Thrive, Not Just Survive, As Economic Seasons Change
Within our last two monthly editorials, we’ve offered a high-level discussion about how economic variables might change under the new Administration. Among other things, we discussed how a weaker dollar might characterize the coming economic environment, and how such might create opportunities for investors going forward.
Newly appointed treasury secretary Janet Yellen has spoken on many occasions in recent weeks about the need for increasingly greater amounts of stimulus. On Monday, the 22nd of February, the House of Representatives voted on a nearly two trillion-dollar stimulus plan. Funding for that stimulus will come from a complicit Federal Reserve that will be compelled to print additional money as it did last year to fund the CARES Act.
As additional dollars are printed, the ones that previously existed become less valuable. We call this debasing the currency. Therefore, investing in anything, the value of which being a function of a strengthening or weakening dollar, is an opportunity.
Broadly, such market sectors would include materials, commodities, precious metals, and energy. Anything denominated by a weakening dollar could experience a positive reinforcement in terms of its price.
We’ve also discussed how weakening dollars and rising taxation often does influence consumer spending behavior, and we’ve described how patterns of behavior can change when the product or service is economically elastic or inelastic in nature.
We’ve observed many similar economic characteristics of the Obama Administration within previous commentaries. I drew reference to the eight consecutive years of slowing velocity of money, stagnating wages, and higher liabilities of taxation in the past, and how these things impacted consumption behavior of both corporations and individuals. Now we must consider how the return of these and other variable might impact patterns of consumption in a post COVID economy.
Changes in Consumption Behavior
As individuals and corporations are left with fewer net spendable dollars after tax, and the purchasing power of the remaining dollars becomes increasingly weaker, it incentivizes a change in consumption behavior. On the corporate side, it becomes a function of what makes the company more efficient rather than on increasing the capacity to make widgets. On the individual side, it incentivizes a focus on the consumption of staples over luxury items. Historically, we can also see how this incentivizes a higher level of savings.
For example, in such periods of time, individuals will be much less likely to decrease consumption of toilet paper, household pharmaceuticals, dishwashing detergent, bars of soap, and basic food staple items. Conversely, individuals will not be incentivized to purchase greater quantities of that seven-dollar cup of designer coffee.
This is a high level example of consumption behavior changing in deference to things that are economically inelastic over the consumption of things which are economically elastic. Investment opportunities are generally found among companies that produce the things, or provide the services, that you will consume regardless of the state of the economy. These companies are generally very large, value in nature, and often times offer a dividend stream of income that is helpful in the reduction of overall portfolio volatility.
Let’s Talk Relationships…
We’ve also talked a lot about correlation. When we are working with clients to identify investment opportunities, we must pay particular attention to what we call correlation. At a high level, you can think of correlation as simply the relationship between sectors.
For example, I believe that utilities as a broad sector could be an attractively defensive investment opportunity as we evolve into the economic conditions that may be ahead of us. However, I would not suggest that people blindly invest into just any company in that sector. You must further screen for correlation with coal for example.
I believe that the Biden Administration, like the Obama Administration before, has indicated a policy aversion to fossil fuels. We can anticipate that tighter EPA regulations, and carbon footprint taxation will negatively impact not only the fossil fuel industry going forward, but also negatively correlate to other sectors that are dependent upon fossil fuels.
There are many power generating utilities that have a high correlation to fossil fuels, and in particular, to coal. Therefore, I would look for utilities that generate the majority of their power through alternative sources such as hydro, nuclear, wind and solar, rather than companies that produce the majority of their power through coal fired steam plants, in order to avoid the negative correlation between the generally defensive nature of utilities, and fossil fuels.
Making the Most of EVERY Opportunity
We’ve spoken often about the changing of seasons, and how such change impacts behavior. In July, we generally wear shorts and T-shirts as the warmer weather incentivizes the utility of our fashion behavior. Generally, we do not wear shorts and T-shirts in January. The colder weather incentivizes our behavior to wear jeans and jackets instead.
Likewise, as an advisor, I am not simply looking for investment opportunities that will survive the coming change of economic seasons, but rather, I am looking for opportunities that could potentially thrive. To some degree, we can observe previous periods of changing economic seasons for those clues about what might thrive tomorrow.
This is where financial physics comes in handy. Understanding the cause-and-effect relationship helps in determining what might happen next. We are constantly evaluating that with our clients. Again, I would strongly suggest to anyone reading this article, that this is no time for a portfolio to be left on auto pilot. If you work with a financial professional, then engage that person frequently at this time. If you are without such professional representation, please give us a call and we would be happy to make your acquaintance.