Times have changed and so has inflation!
There’s a shift going on with businesses where businesses are investing, across the board are investing more and more into the digital world so they are upgrading their software. They’re trying to automate a lot of processes that were done manually before, and businesses were very slow to implement some of these changes, whether it be using a CRM system. A modern CRM system, which is customer relationship management or a more modern billing system. After the financial crisis, we had a few years where there just wasn’t enough demand. Businesses were very reluctant to invest in new technology. During the last four or five years, we saw a big push towards some of these new technologies. Finally, as COVID happened last year. Businesses were forced to invest even more in some of these technologies as people could not travel. They had to work from home and things like that. So these companies, your Amazon, Google, and Microsoft. They basically form their own cloud infrastructure. And all that means is that instead of companies having to invest in computing power and computing being on-premise. Now, these servers with tremendous computing, capacity tremendous storage capacity, really supercomputers can be somewhere else and someone sitting at home can access those servers to what’s known as a cloud. What’s amazing about these tech companies, your top five-six tech companies, is that not only do they own this critical infrastructure but their addressable market is huge. It’s basically the entire world. Of course, there are some issues with China, for example, China does not allow Facebook and Google. But otherwise, pretty much the rest of the world is, there’s a market for these companies. So all of a sudden there was a realization that these are extremely valuable businesses, and they are here to stay. The trends that are driving these businesses are multi-year trends. They’re not just a trend that that’s short-term. You’re starting to see more and more value investors get into the so-called tech companies that started way back about 12 years ago with Ben Miller, who was a famous value still is. He invested in Amazon. Tech companies are, and some of these large tech companies made a nice move after March of last year. Then they sort of went nowhere for almost eight or nine months, and now you’re starting to see them make a move again.
Inflation becomes a problem when the central bank begins to fight inflation because fighting inflation is tantamount to curbing growth. What do you do when you fight inflation as you increase interest rates? That’s the way you begin to try to curb the money supply. You take liquidity, out of the market. The central bank was the most effective at doing this in the early 80s, with Paul Volcker, but interest rates had to go very very high. In order to shut off the economy, much higher than anybody thought they would. It’s a question as to how hot the economy really was at that time. It wasn’t so much a factor of whether the economy was too hot or not, its inflation was what it was. Now some people say that inflation is caused by a hot economy. Others say that inflation is purely a monetary thing. There’s a lot of money in the system no matter how well the economy’s doing the money will chase goods and services. That would be called stagflation if the economy was not doing well in the money. I would say the economy is doing somewhat okay but not great. And you’ve got inflation. The inflation that we’re getting is not from the economy doing so great.. it’s stagflation.
The closest example that we have is, maybe 1978 79 period, when there was stagnation… so the theory was started at 74. There was this notion amongst macroeconomists that inflation was correlated to unemployment. So if unemployment is low then inflation is high- inversely correlated. And that notion was disproved in the mid-late 70s. When inflation was running high but unemployment was also high it was called “the Phillips curve.” We did see something very similar. In the last few months the last inflation reading was 5.4% Before that it was 5%. Yet, unemployment is still pretty high. I think, officially, it’s about six and a half or 7% now. So the question is that, unlike the 70s, is this a temporary phenomenon where there were supply-side issues that resulted in this high inflation we are already starting to see commodity prices dropped. I was reading, oil or gasoline is pulled down to around $2.80 Number prices have dropped over 50%.
I was reading the commentary on that, and it was an interesting perspective, talking about companies that have been building up inventory. You had an inventory shortage during COVID. Now, they have been building up inventory when the demand for all the commodities was through the roof. But then, as the consumer demand for some of these products drops- as a supply and demand balance out-They’re gonna be left with high inventory. Then you can really start to see commodity prices fall off the cliff because the demand just goes away. They’ve ramped up supply, and then the demand goes away, which is deflationary.
When you think about commodity prices being the cause of inflation, they are not really as inflationary as they were maybe back in the 60s and 70s. Part of the reason is that input costs, when it comes to most goods, have become smaller and smaller. Any good the majority of the cost is now packaging, marketing, and inflation over the decades. So, you could argue that even if commodity prices go up as they did in the 70s we may not see as much inflation. Just because commodities are not really that high of an input.
If you get away from big tech, which is growing its business through the cloud. There are now 700 companies, trading at, 20 times sales. They’re trading way above the price of their cash. A lot of these are trading above their cash value so they may have say 2 billion cash but they’re trading at 15 billion. You have companies with a $15 billion market cap that have very little business. And what’s happened with some of these SPAC’s- they become what we call story stocks. The SPAC promoters come out with this great story like everyone’s going to drive electric cars, everyone gets excited. The company goes public, and people are willing to pay these astronomical prices for the SPAC. Since February, we’ve seen a big pullback in a lot of these stocks.
It was a pretty good sell-off in the market on Monday. Since then it’s rallied back. You look at the Dow, the S&P, the NASDAQ… They were all off around 3% from their highs ballpark. But the Russell was off about 10%. You had this big dislocation between the really big companies, strong balance sheets versus small companies. What’s amazing is that these big tech companies have become the safe haven in this environment.
They used to call them traditional IRAs because there was no such thing as a Roth. This was in the late 70s. Nobody thought they would ever amount to anything because you only put 2000 bucks a year into it. Well, guess what, they did. I’m not exactly sure when but probably around early 1990 late 88 Something like that. They’ve gotten really big. It’s one of the best things that, especially a young person can do for themselves financially. The gist of a Roth is the money goes in, you pay tax on whatever goes in, so it’s after-tax contributions. But then when it comes out, it’s tax-free versus a traditional IRA which would also be like a 401K or 403 B, it goes in pre-tax so you get the upfront deduction, but when it comes out it’s taxed as regular income. So, the longer you have to leave the Roth in the account, hopefully, the more can grow, and the more tax-free money you have. It’s a phenomenal deal. A lot of people aren’t familiar with some of the finer points on the mechanics of how a Roth IRA works and some of the things that you can do with a Roth IRA. When you take a withdrawal from a Roth, the order from a tax perspective, it always comes out. Your contributions first, then conversions and I’ll talk about conversions in a second. and then earnings. So contributions conversions earnings. Your contributions are, you can access those at any point. So, let’s say you’re 25 years old, you put $6,000 into a Roth IRA. Something comes up the next year, you need $6,000. And let’s say the account just is flat, didn’t move, and is worth $6,000. You can take your $6,000 out with no penalty. Now, the second part of this -conversions. This can be a very powerful thing. You can convert pre-tax IRAs to a Roth IRA. So let’s say you have an IRA, and it’s worth $25,000. You can convert that Roth IRA, or that that traditional IRA to a Roth IRA. Now, when you do that, you pay taxes on the 25,000 that you convert that’s taxed as regular income in that year. But then it goes into the Roth, to grow tax-free- not tax-deferred- tax-free for however long you leave it in. Now, back to the withdrawals. So remember contributions, somebody can access contributions at any time. Conversions. This is one of the finer points, the Roth IRA has to be open for five years before you can pull out converted money without a penalty. So, this is where having an advisor to be able to help navigate some of these finer points is important.
Let’s say you have a Roth 401k And you retire, and you say, “I’m going to roll it to a Roth IRA, and then that year I’m going to take a distribution from it.” Well, you have the five-year rule that applies to the Roth IRA that you rolled it over to. It has to be in the account for five years to be a qualified distribution-Meaning no penalty associated with it, or potentially have a portion of the earnings become taxable income. So that means you didn’t get a tax deduction and you’re paying tax on the way out, which is not a good deal. If you have a Roth 401k It’s probably a good idea to open a Roth IRA, even if you fund it with $1 to get that five-year time frame so that way you can make the withdrawals from it. There are a lot of moving parts to a Roth. The concept is simple. We preach that all day long-start a Roth IRA! There’s a lot of flexibility in what you can use it for…Exceptions for education expenses for first-time homebuyers, things like that where you can access it if you need to. So, if you don’t have a Roth IRA, the younger you are, the better. Give us a call, we can give you details and tell you If it can fit your situation if it makes sense for you. There are income limits for a Roth for 2021. The income limit for married filing jointly is $208,000. If you make more than $280,000, You can’t contribute directly into a Roth IRA, or if you’re not married, it’s 140,000, depending on your age, you can contribute either 6 or $7000 a year to a Roth. With a Roth IRA, they’re points that you need to be aware of to actually get the real benefit of a Roth.
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