Hello friends,
Spring is almost upon us. Good news is everywhere. Covid vaccine availability is rapidly increasing. The kids will (finally) go back to school. The “terrible” 3-5% correction in stocks in January was short lived. States are reopening (I am currently in Jupiter FL which has been mostly open for a while). The only negative development is for the people who run at you from 200 yards away to get in your face - i.e. within 6 feet - and tell you you’re not wearing a mask while hiking through the woods (this did not happen to me but to a friend while on a jog at 6:00AM). Those folks will have to find a new “passion.” For the rest of us, brighter days are ahead.
Tax Changes Coming?
While we are basking in the good news, let’s discuss some planning ideas that we need to focus on this year. As I mentioned in a client email, taxes are going to be a major focus this year. What is clear from the ideas proposed by Biden and others is that people earning over $400,000 would lose all gains from the trump tax cuts and then some. Basically, increasing the tax rate and bringing back limits on itemized deductions (such as mortgage interest etc) are two of the reversals from the previous tax change.
New items for the upper income folks include a drastically higher capital gains tax (to the point of why invest outside of an IRA when you combine 40% tax rates with 10% state tax rates in places like NY and CA. take 100% of the risk and only get 50% of potential gains - sounds awesome:/). A more potent proposal, that actually will affect almost all of my clients is the proposal to eliminate a stepped up basis at death for capital assets. This is the law that - to put it succinctly - would allow your kids to sell your house after death with no tax. They’d really like to tax you now. In fact, this tax would generate more revenue for the government than the estate tax. But I don’t think this would fly. In fact, I think most people don’t stay awake at night trying to think of ways to maximize government revenue.
Tax Planning
Tax Planning is really coming to the forefront. With reduced deductions and more taxes, AND with the tax code favoring renewable energy, I am going to couple of ideas. First is an idea that I first covered in a blog post years ago. That post was about beating inflation with one idea being investing in things that ELIMINATE future costs. For example, if you get a tax break to install solar but no tax deduction for your electric bill, it might make sense to make that investment. Cut an expense and get a tax break. Second, I think that using the Roth IRA and Roth 401k more fully make sense. Tax free investing - quite simply - eliminates a lot of future worry. These join a number of other advanced strategies that our tax team and I are working on. I am in the process of reviewing client situations to develop strategies for each if it makes sense to take strategic actions (and we have already with a number of clients as some of you know). .
Financial Markets
The markets have been rampant with speculation in small (and large) memes and ideas throughout 2020. It continued a bit into 2021. now the favorite ideas are “reopening stocks” which started moving up November 4. I do think there will be a huge rush to travel and dine out by July (many people have pent up savings). However I think that gets back to 85% not 100% pre covid. I am going to go out on a limb and say that 10-20% of people are happier with their new simpler lifestyle and the money they’ve saved. Which in my guess, means less than 100% recovery for leisure. But that still is 75% to 100% higher than business is now. So I expect re-opening stocks to continue moving up. In other news, the race to secure local natural resources is moving full speed ahead. Both Europe and the US are supportive of local supplies of nickel, uranium, rare earth metals, cobalt, lithium etc.
Interestingly, with increased demand in re-opening stocks, money is coming out of large tech and speculative stocks that did well during 2020. The issue this presents is that the stocks being sold represent much more influence on the stock indices like the S&P 500. Which means the major index can go sideways or even down for a bit while airline stocks, regional bank stocks and theme park stocks shoot higher. it may reinforce my theory that active management (and inflation themes) will be key in the 2020s where passive investing may seriously lag (note: remember the special report I produced last year on this which can be found HERE).
Interest Rates & Inflation - Boston’s Annual Cost of Living Increase 10.4%??!!
Rising interest rates - reflecting possibly the expectations for some combination of less bond buying, more growth, and inflation expectations have been nipping at stocks around the edges. Prolonged higher rates will take down the stock market if they continue. The strange thing is, that policy makers have you believing that this is a bad thing. They say targeting 2% inflation and keeping rates low is “good for growth.” Well it is in a Zimbabwe sort of way.
I say, what’s wrong with 1% deflation? With technological progress, why do things we make go down in price but the things we need to live, go up in price? Why would the Federal reserve purposely try to make costs go up - cost increases which hit lower income people the most? You see what low rates do for stocks and houses (for people with assets)? Now the solution from government is more taxes. But I say they are missing the problem. Government created an excess wealth for the rich by allowing them to borrow at 0% and by making bonds and bank CDs un-investable at 0.58% returns. They force people in stocks and real estate, creating the bubbles and then wonder why the rich get richer. And on top of it, as I mentioned above they make the cost of living go up for regular people. I like to say that a 6% CD would solve a lot of these problems.
Yes, wealthier people would not get stocks going up 20% per year. And houses wouldn’t go up 10%. They may even drop a bit. But that’s a free market. it’s likely living costs for everyone would decline and grandma and “pipe fitter Jimmy” wouldn’t have to risk the stock market to accumulate wealth. Our government likes to measure GDP growth to show that team USA is winning, but GDP is not a person. As you may all know, I have no problem with the rich getting richer, but when the government promotes it, then goes on TV saying the opposite, then I think they are either liars or have no idea what they are doing.
As an aside, Twitter, Spotify, AirBnB and Beyond Meat are all offering convertible bonds that pay NO interest. And convert to stock at much higher prices (Source: FT). This would only be possible in the deranged interest rate world created by our central banks (rates are the price of money, if money has no price, where are we??? The value of all assets are based on the risk-free rate which is a divisor, so if that rate = 0, then the [price of assets = infinity).
Here is the work of financial planner Ed Butowski. He created the Chapwood Index which he feels correctly measures annual cost of living increases for each city. From the 5 years to 2019, he says that Boston has experienced an average annual cost increase of 10.4%!!! Well above the “target” the Fed claims we are aiming for but haven’t hit yet. What makes the difference? Butowski claims that government “cooks the books” on inflation mainly to keep their expenses low. You can go to his site linked above for a more full explanation.
I’m not sure if Ed is accurate but I believe cost of living increases have not been under 2%. Yes iPad prices have held study but how often do I buy an iPad? We more regularly pay for food, electricity, health care, home maintenance, child care, and college costs. All of which have experience outrageous average annual increases in price.
Note: interest rates are moving higher. We may see a real battle to test the “power” of the Fed. if interest rates rise due to inflation concerns, will the Fed go beyond ridiculous to try to stop it? That would be part of “Project Zimbabwe” also. it’s all in the playbook . unfortunately.
Lets Get Our Definitions Straight
My final beef with this is that inflation gets misused - inflation by classical definition, is an increase in the money supply which causes the value of currency to drop - meaning more currency is needed to buy something. Now, whether that supply goes to you directly or through the Fed to buy government bonds, we have inflation.
Cost of living increases get mistaken for the term inflation but they are often a result of inflation (think 1930s Germany with kids pushing wheelbarrows of money or Zimbabwe using money as firewood). We do have inflation and as I stated in my Paris Hilton email, we haven’t done anything financially responsible in decades and we are living off the foundation created by people in the past. A stable currency is a wonderful thing that many in the world can only hope for. And here we are abusing it. if it hasn’t occurred to you, this issues bothers me tremendously. Mainly because few understand it and government can get away with it.
We will pay for this. As a student of economics and history, I will say there is a very high chance that we will pay for this. The only challenge with macroeconomic speculating is that these events often take years to develop, then seem to happen all at once. So whether we are 2 years or 15 years from major currency problems I don’t know. But I feel that the 2020s will somewhat resemble the 1970s, which presents an interesting set of challenges for us all.