Big Government — Unintended Consequences? Or Intended?

Stock Talk School: Hear insights into the inflationary forces that are underway, including higher home buying and rental costs ahead. A big federal footprint from the tax and spend agenda pursued by Democrats is having an impact. Chief Investment Officer Chris Perras for Oak Harvest Financial Group, wealth management and financial advisor in Houston, Texas, shares his perspective.

Chris Perras: Happy Friday. I’m Chris Perras, chief investment officer at Oak Harvest Financial Group. We are an investment management and retirement planning consultant here in Houston, Texas. Welcome to our May 7th weekly Stock Talk podcast: Keeping You Connected to Your Money. We’re sitting in the normal post-tax day, second-quarter slop and chop of a normal first year presidential term, and one of those waiting to go slow periods. Having prepared our listeners weeks ago for this time period and given more of this slop and chop is likely to continue through the rest of the second quarter, I wanted to take this podcast to focus on a few longer-term economic and stock market issues.

Time and time again, over the past 9 to 12 months, I’ve been asked by clients and prospects, “Chris, if you aren’t worried about politics in Washington, DC, if you aren’t worried about COVID or aren’t worried about higher taxes and their effect on the stock markets, what worries do you have?” This podcast is directed at this topic. This week’s title, Big Government, Unintended or Intended Consequences. You tell me. The democratic agenda of tax and spend has been laid out in its entirety the last two months with president Biden and the Democratic-controlled Congress proposing three gargantuan spending programs.

A small portion of these programs are true infrastructure as most of us think about it. While most of the new spending bills are supplemental income and expanded benefit programs, largely under the disguise of much needed infrastructure spending. President Joe Biden’s $4 trillion economic vision for the US rests with democratic lawmakers who will try to navigate a narrowly divided Congress. With his $1.9 trillion pandemic rescue package, already law and the checks already in the mail, President Biden has set forth a $2.3 trillion infrastructure and manufacturing plan and a $1.8 trillion policy bundle aimed at what liberals see as America’s social ills, but the infection rates of the pandemic are falling in most states and the urgency of the pandemic is waning.

The fight in Congress to pass these bills will likely be extended into 2022. We can debate and likely will for months the need for such large programs, both their need in size, given our rapid recovery and upward trajectory in the economy. We can debate these things for months, but I’m not going to do that. What I am going to do is point to their current and future unintended, or who knows, maybe intentional consequences on our economy and likely on the markets in 2022 and beyond. The number one most likely unintentional consequence of these programs is likely to be secularly higher trending inflation.

Now, I’m not talking about or expecting rampant inflation like the 1970’s or, worse yet, hyperinflation like Zimbabwe that so many fear-mongering newsletters like to scare people about. No, I’m just expecting generally higher levels than what we saw in the 1990s and 2000 periods when we consistently undershot the Federal Reserve’s 2% goal by coming in around 1.8% on the inflation rate for those two decades. For what it’s worth, most of these writers and economists have been wrongly touting this concept for 5, 10, and even 20 years. Technology and its productivity gains should continue to suppress runaway inflation.

However, I believe inflation was already troughing secularly in late 2019 and early 2020 due to the rapid increase in population groups clustered in the millennial and Gen Z age groups, which now make up over half of the US population. What our federal government has done in response to the pandemic the past 15 months fiscally and monetarily should increase the overall longer-term inflation rate of the US for the foreseeable future. Increase it, make it higher, but not draconian.

However, our federal government response by way of income replacement programs in the second half of 2020 and the continued overuse of these programs this year is contributing to a higher transitory, and that’s Jerome Powell’s term, inflation rate currently. Prices of lumber, and copper, and steel have risen well beyond my lofty expectations that were set last year by multiples the last 12 months on the back of supply shutdowns, coupled with excessive demand being generated by these income programs.

Lumber pricing is up almost five fold in 15 months, while the lumber growers are receiving very little more for their newly cut logs. Our friends at Guggenheim have provided a great chart on the spread between lumber prices and raw timber prices. Let’s just say the tree growers aren’t the ones to blame for your higher housing costs. That would be decades of planning for a just in time economy with very little “unproductive idle inventory in our system and supply chains”.

Housing prices are escalating at the fastest pace since the housing bubble of 2006 through 2008. While this does not immediately affect me, except for the cost of my new fence that I want to build, it will contribute to a higher future inflation for those not even looking to buy a new home. How? Well, home price increases will translate into higher tax assessments on current housing supply, and my and your future house tax assessments is likely going to be much higher in the future.

Whether this is what the politicians in the federal government intended, I don’t know, but I do know that it’ll drive up tax receipts for local governments in the future and thereby lower my free cash flow available for discretionary items. Unintentionally, these programs will drive up the cost of renting apartments and other lease-based housing as more millennials and Gen Z’ers are priced out of the home buying market. Think all the way back to 2017 and 2018 and that normal. We’re likely to see that again.

Anecdotally, my older son, Kyle, is looking to relocate out west for his new job, and the apartment rental company raised the monthly asking price for his rent by 10% in just two months that he waited to rent. Other inflationary inputs were already rising as well pre-COVID. Increasing momentum to raise the national minimum wage to $15 per hour was already gaining ground pre-COVID at the state level. As part of the COVID relief bills, we taxpayers have been paying additional unemployment benefits in multiple one-time COVID relief payments to millions of Americans affected by the pandemic.

While noble, and I believe the right in their purpose, they appear to have become overly generous and excessive in their size and timing. Walk into any restaurant here in town and ask the owner or manager what their number one issue is right now. Is it demand? Is it how many people are walking into the restaurants? No, almost universally, they will say rehiring their previous hourly workers is their biggest problem. Is it because they’re offering not reasonable pay? It doesn’t appear so as most of the managers I talked to are looking to pay well over the $15 an hour minimum wage and provide multiple hours of work.

Federal statistics reported almost 7.5 million job openings for about 9 million unemployed Americans out there. Clearly, if one wants a job, there are openings out there. Well, the problem is not with the job market. According to the people in the trenches I talked to, the issue is that many of these managers looking to hire back into the service and leisure economy are competing against an invisible enemy. Who are they competing against? They’re competing against your politicians in Washington, DC, and their COVID relief programs.

With extended unemployment payments through September and your federal government writing direct checks to people, many hourly workers are just saying it isn’t worth going back to work yet. Yes, sitting at home and collecting a check without working is very profitable right now. So profitable that the incentive not to work is very high at the lower wage level provided by the service sector or more difficult physical labor-areas of our economy.

I am not here to argue with these individuals’ motivation. What I am here to do is to say that one of the unintentional consequences or perhaps intentional if you’re a conspiracy theorist of these pay-to-stay-at-home programs is going to be to drive up wage inflation in 2022. Why? Because these restaurants, construction, and other service companies are seeing a rapid increase in demand. This will likely continue through the second half of this year and into 2022 on the back of the service economy in the United States reopening more fully.

To compete with the federal government income replacement program, business owners will be forced to increase their wages and benefits to their new employees. Listeners, in a predominantly service-driven economy such as the United States, this is how we get an overall uptick in inflation in developed economies through labor and wage costs. Is this being intentionally driven by politicians? No, I don’t think so. I don’t think they’re that smart at how businesses have to operate, or I don’t think they look forward that much, but it is how inflationary forces begin to bubble up under the surface, whether they’re on purpose or as an accident.

So, listeners, does this mean that this is the end of the bull market? No, not at all, but what it can mean is that what works and leads the market and what does not work and what lags the market can change. Is that any different than any other 12 to 18 month-period in stock markets? No, not one bit. We entered the summer doldrums that buy our work started on tax day, three weeks ago, since 1991. Over 30 years when the year-to-year price change in the S&P 500 was over 30% year over year, which has occurred only 10 times before now, now being the 11th.

Over the subsequent 9-month period, the average gain from the peak was 8.1% and all 10 time periods were positive. After 12 months, that average gain was 13.5%. All-time periods were positive. That says to our team, putting up with some summer chop and slop will be well worth the noise. The current timing and downward move in the markets is having the opposite effect that most emotionally charged investors will likely feel over the coming 48 weeks.

It is lining us up to be even more positive in the second half of 2021 through early 2022. A normal pullback on the S&P 500 during the late second quarter in a first presidential year is in the 4.5% to 6% range, not the 5% to 10% or 10% to 20% canyon-wide estimates of any forecast on TV. Such a move would place the S&P 500 just below its rising 50-day moving average and, should that happen in June, take us back to around 3,985 to 4,025 on the S&P 500.

Please do not panic about this forecast, because that is merely where we were at the start of the second quarter. A move down to that level would set us up for a very similar move in the second half of 2021 through early 2022, like the recent pre-election buy point of 3,250 in late October to the current stall and pullback point of around 4,150, 4,200. Yes, you heard that correctly. While the early 2022 S&P 500 forecast remains 4,600 to 4,700, there is an increasingly high chance that the S&P 500 has a blow-off move into the first quarter of next year that can approach 5,000 on the S&P 500.

What does that take? It takes quiet and calm. That’s it. It takes an increasingly sleepy market, particularly in the fourth quarter of this year. That’s all. Do not fear a sleepy market. If you want a real earthshaker, here it is. I’m thinking there’s a strong chance that the yield curve is peaking for the next 12 to 15 months. It’s just my read on the charts and the normalcy of this cycle. My thoughts are that we’re near peak growth right now and peak steepness in the yield curve.

“What does that mean to my listeners?” you might ask. This would have a huge implication for what groups and sectors investors want to be buying in overweight the next two to three months as the market were to sell-off. What groups? Many of the ones that are now being tossed out as they are “no longer leading groups”. Listeners, that’s code for they aren’t going up as much as the overall market.

Stand by. I will have more on this subject in the coming weeks and months. For, as I say, macro themes do not change overnight. They change gradually, and then they tend to persist for the better part of a year to 18 months at least. After July 2nd and no later than Labor Day this summer, big investors will once again be looking forward. They’ll be looking out to the second half of this year and all of 2022. What are they likely to see? They’re likely to see that higher secular growth companies that peaked all the way back in mid-2020 have now stalled for a year. Their evaluations have compressed, and now they look cheap versus their long-term growth and free cash flow profiles.

Our goal is to keep you and your money working for you throughout your retirement years and keep you informed about what we’re seeing and planning on doing with your money well before you see and hear it on the financial news channels. Give us a call, let us help you out. At Oak Harvest, we are a comprehensive investment manager and retirement planner located right here in Houston, Texas. Give us a call to speak to an advisor that can help craft a financial plan that is independent of the volatility of the stock markets. Give us a call here at 281-822-1350. We’re here to help you on your financial journey into and through retirement planning. I’m Chris Perras. Have a great weekend.

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