Is the U.S. doomed by today’s inflation? The answer is NO. Here’s why… [Wednesdays: The Independent Investor]
Miles Everson’s Business Builder Daily speaks to the heart of what great marketers, business leaders, and other professionals need to succeed in advertising, communications, managing their investments, career strategy, and more.
A Note from Miles Everson:
Welcome to today’s “The Independent Investor!”
In this article, we’ll be talking about one of the most commonly discussed topics in today’s financial markets and some practical advice to avoid worrying or panicking as an investor.
Ready to know more?
Keep reading the article below.
The Independent Investor
Professor Joel Litman, Chairman and CEO of Valens Research and Chief Investment Strategist of Altimetry Financial Research, has been on the move ever since the easing of travel restrictions.
At one point, he traveled to 5 different cities in 3 continents in just a span of 6 days.
That’s literally a busy week!
While traveling, one of Professor Litman’s observations is that everywhere he goes, lots of people are talking about one thing: Inflation.
He states inflation is in almost everybody’s minds, and the global financial media keeps talking about how rising prices will destroy the economy and contribute to higher unemployment rates.
Here’s the thing: Professor Litman says that may be true in many emerging markets, where the cost of food and power takes up almost all of a person’s wages.
However, in the U.S., he believes the idea that the country is headed for a repeat of the market crisis in the 1970s is just ridiculous. Why?
It’s because while inflation was an accelerant of the economic crisis back then, it wasn’t actually the main cause.
Here’s what you need to know more about inflation…
Inflation Alone Does NOT Cause Bear Markets
In the 1970s, the U.S. market went through a period called the “lost decade.” Inflation notched above 10%, and it coincided with terrible “stagflation”—a period of huge unemployment and flat (if not negative) economic growth.
That time, the country went from making up 40% of the world’s economy to making up just 28%. Simply said, it was one of the worst bear markets in U.S. history!
However, inflation wasn’t at the heart of that crisis: Corporate credit was. So, while interest rates soared, lenders stopped lending because they feared mass defaults. That same pattern happened in the Great Depression from 1929 to 1939, and in the Great Recession from 2007 to 2009.
During these times, corporate credit fell apart and bankruptcies ran rampant.
What other factor was present during the “lost decade?”
In the 1970s, marginal tax rates, or the highest real tax bracket for earners, were above 70%… and inflation made it even higher as the number soared to 85%. That was the recipe for the perfect storm back then.
Professor Litman says if you look at tax rates around the world, you’ll notice a trend: Higher inflation in low-tax environments can still lead to good economies. On the contrary, high tax rates in lower-inflation environments often lead to stagnant economies.
He adds this concept is what the financial media can’t seem to grasp. In a normal inflationary environment, low tax rates remain low. However, in higher-inflation environments, high taxes hit taxpayers even harder because taxes are based on nominal gains, not real ones.
The bottom line?
Inflation alone doesn’t drive bad economies and equity bear markets. Without the other factors mentioned above, markets may be volatile but economic growth and valuations can still prevail.
This realization is the reason why the former U.S. President Ronald Reagan sought to lower tax rates during his presidency. Professor Litman says had it not been for those tax cuts, the country wouldn’t have recovered in the 1980s and 1990s, and retained its economic dominance.
The U.S. will Come Out on Top of Today’s Tough Economic Environment
According to Professor Litman, while the country is in a time of relatively high inflation nowadays, taxes are relatively low (at least for now). This means the market is unlikely to experience a 1970s-style “stagflation” anytime soon.
“Stagflation” only happens in a super-high-tax environment that the U.S. currently doesn’t have.
So, as an investor, remain calm about inflation and ignore the mainstream financial media’s “noise.”
The economy will settle back down, although it will just take a little time.
Always remember that inflation alone doesn’t have the power to derail the world’s economic machines. This means today’s economic situation is not the same as what happened in the 1970s, no matter what the headlines say.
We hope you learned a lot from today’s topic!
(This article is from The Business Builder Daily, a newsletter by The I Institute in collaboration with MBO Partners.)
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“Wednesdays: The Independent Investor”
To best understand a firm, it makes sense to know its underlying earning power.
In two of the greatest books ever written on investing, the “Intelligent Investor” by Benjamin Graham and “Security Analysis” by David Dodd and Benjamin Graham (yes, Graham authored both of these books), the term “earning power” is mentioned hundreds of times.
Despite that, it’s surprising how earning power is mentioned seldomly in literature on business strategy. If the goal of a business is wealth creation, then the performance metrics must include the earning power concept.
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