Inflation: Secularly Higher

 

 

 

Retiree and near retiree investors have a multitude of financial worries. One of the first things I learn at OHFG almost 5 years ago, is that while retirement life might be functionally less complex than one’s working days, one’s financial life grows more, not less complex, at or in retirement. Major questions arise like where is my cash flow going to come from to meet my spending needs? When should I take social security? How much is my RMD, required minimum distribution from my retirement savings? What is my optimal income level, so I don’t pay MYGA tax penalties. Will my savings last until I die? And for the last 2 years, at the forefront of investors’ and those on fixed incomes minds is the question, will I be able to keep up with inflation?

For this video, I’m going to discuss our thoughts on the future inflation rate over the next decade. No, I’m not going to provide you a static number to plug into your spreadsheets, but I’m going to discuss three factors that I believe will keep the inflation that consumers experience higher than both the Feds 2% goal and the levels we experienced in the 1990’s through 2020 when technology and offshoring helped keep reported inflation below the Feds 2% goal.

Before we get into this week’s topic, Inflation Secularly Higher, please take a moment to click on the subscribe button and click on the notification bell so you will be alerted when our team uploads our latest content. We do have a new location for our Oak Harvest Investment oriented content. You can find it by typing “Stock Talk with Chris” in the Google search window or going to the Oak Harvest You Tube channel and clicking on the drop-down tab labelled “channels” and clicking on “Stock talk with Chris”.

Every good retirement planning software program has an input for inflation expectations. While I certainly underestimated the height of cyclical inflation peak caused by the global response to Covid, pre-Covid I was arguing for higher future inflation rates than the last 30 years. 4-5%? No. But higher than 2%. Why? 3 Major reasons jump out.

First, Demographics.

There are roughly 104 million Americans between the ages of 20 and 44 in the US with another roughly 100 million more Gen Z Americans behind them. Close to 150 million American fall between the ages of 19 and 54, according to the 2021 Census and BLS, Bureau of Labor Statistics.

 

These are the prime spending years for almost every major economic category that are inputs into our governments CPI statistics, food, clothing, housing, energy, and transportation costs. Millennials, who recently overtook the Baby Boomer demographic, and most members of Generation X are still in their spending sweet spot years, and most will remain so through mid-next decade. This is at the same time that while the total number of Baby Boomers is now declining, their average age is lengthening and they are consuming more units of more costly medical care and drugs, that even without directly including health insurance prices, account for over 8% of the CPI inflation basket.

New medical technologies, while improving and extending our lives, are driving health care inflation costs higher. Think about the future of drug development and their costs to our economy if and when new Alzheimer’s drugs that work are discovered and covered by insurance. Or more immediately, think about when newer diet and obesity drugs become more commonplace.

Besides these demand pull inflation factors, another demographic issue that argues for higher than prior decade historic levels of on going inflation is the slowing of the “working age” population demographic. Here’s a chart on the St. Luis Federal reserve website showing the slowdown in America’s working age population from the 80’s and 90’s decade until now.

 

 

By the Fed’s own admission there is a labor force “participation gap” of close to 2.1mm workers. These missing workers are needed for our economy to return to “level” and without them ex[ect businesses to have to pay more for workers keeping wage and benefit inflation high and sticky. Unfortunately, further analysis of the Fed data reveals that the LFPG, labor force participation gap, is almost entirely due to the aging US population and lower birth rates and population aging is likely to continue as more baby boomers retire. Here’s that data from Libert street Economics, and a link to their study. https://libertystreeteconomics.newyorkfed.org/2023/03/what-has-driven-the-labor-force-participation-gap-since-february-2020/

 

 

Broad demographic trends such as Baby boomers aging, and the Millennials and Gen Z spending are likely to cause inflation to remain stubbornly over 2% for a while given the labor supply demand imbalance our country currently has. This dynamic can lead to cost/push inflation dynamics across our economy over the coming years.

A potential second cause for continued higher than desired future inflation, federal government initiated spending programs like the ironically named Inflation Reduction Act. Viewers, whether or not you are in favor of ESG movement, socially, I don’t care. We are talking economics and cash costs. The “E” component of ESG has come to represent not only “Environmental” but also a broader agenda of tax payor funded Green Energy expansion. Throw in both climate change regulation and higher enforcement costs and it is inflationary at its core. We are accelerating the rate of spending of tax payor money on expensive and unproven infrastructure at the same time we are restricting and abandoning older, fully paid for and depreciated, functioning fossil fuel energy sources. This is inflationary.

No we are not proceeding at the same unwise decommissioning rate that Europe did the last decade, however current political leadership is pushing us that direction. While the CBO originally estimated that the IRA bill’s Energy and Climate initiatives would total almost $400 billion over the coming decade, more recent analysis by Goldman Sachs revealed that they thought the cost of incentives would ultimately total over $ 1.1 Trillion. Here’s Goldmans estimates.

As a taxpayer and consumer, I find these numbers and the ability of politicians to forecast and budget terrifying. The IRA is quite the opposite of its name. Its rollout is another mark against inflation returning to 2% over the next few years.

The final issue arguing against a return to 2% inflation soon is both America’s and the rest of the western world’s movement to onshore manufacturing capacity and supply chains. Covid disruptions and escalating geopolitical conflicts have created global momentum to lower Americas reliance on foreign trading partners that we disagree with politically.

This is a 180 degree turn from the near 30-year policy American businesses followed of outsourcing manufacturing capability to lower wage cost countries. From roughly 1980 through 2010, we spent 30 years moving to just in time inventory and manufacturing. For decades we strived to carry low or no un-needed inventory lest our companies run the risk of inventory write offs. Almost all-American companies strived to operate an asset light, high intellectual capital, high marginal return on capital economic model. During deflationary times, this is exactly the right thing to do. However, during periods of higher inflation, one benefits by holding higher than normal inventory, because your inventory gets repriced higher and allows easier end market price increases.

Take for example the Electric Vehicle market that the current administration is trying to stimulate by way of incentives in the IRA. Here are the stats on the rare earth metals markets needed to produce an EV. China is dominate in this market and prices for metals have skyrocketed the last 2 years.

 

The political push toward EVs usage by way of “tax incentives” and subsidies and vilification of standard IC engines, is driving new car EV demand and their prices materially higher. This in turn is causing used car pricing to stay near historically high levels because fewer people can afford a new car.

The supply chain American vehicle manufacturers use was efficient for IC vehicle production, it had been optimized over 60 or 70 years. However, it is not efficient for EV manufacturing. The start-up costs, inefficiencies, and learning curves manufacturers endure get passed on to American car consumers in the way of higher vehicle prices.

The trend to on-shoring will have this dynamic playing out across a range of consumer facing industries. Currently, China accounts for 63 percent of the world’s rare earth mining, 85 percent of rare earth processing, and 92 percent of rare earth magnet production. Rare earth alloys and magnets that China controls are critical components in missiles, firearms, radars and stealth aircraft as well as more mundane manufacturing plants. This is the third dynamic that makes a drop to 2% in the CPI very hard any time soon.

 

Unfortunately, while our team is expecting a materially drop in inflation this summer, we are not expecting a secular return to the 2% or sub-2% level soon.

Viewers, there is no perfect investment philosophy, there is no all-weather equity strategy that outperforms every stock cycle or in every economic environment. However, long term research finds partnering with an advisor can add value to your portfolio and retirement by helping you minimize estate taxes, maximize social security timing, and remove some of the emotional whipsaw that many investors feel during times like this that causes them to make emotionally biased decisions in their investment portfolios or allocations

At Oak Harvest, we have many tools, both market based and insurance based, to help our clients try to keep up with inflation and meet their retirement goals and objectives. We are not just an investment manager solely focused on the stock and bond markets. We have specialists in the fields of tax preparation. We have social security experts to help with when to take SS, and we have insurance experts who can help you construct life, health or medical care backstops should you need those in future years.

The OHFG team serves our clients by helping them plan for their future needs, instead of focusing on the past. The future and stock markets are always uncertain and that is why our retirement planning teams plan for your retirement needs first, and your greed’s second.

Give us a call to speak to an advisor and let us help you craft a financial plan that helps you meet your retirement goals. Call us here at 877-896-0040 and schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years.