As equities continue to edge higher into new record territory, investors continue to receive a mixed bag of economic news. Last week, most notably, bond yields edged lower while key economic reports were mixed. Friday’s employment report showed surprising gains if one looks at the employer survey, but a less robust picture if one looks at the less statistically robust survey of homeowners.
Indeed, what appears to be happening is a further bifurcation of our economy where those well off financially are seeing increases in their wealth that more than offset the ravages of inflation while those at the bottom of the wealth pyramid can’t keep up even though most are gainfully employed.
What’s happening mirrors the world a decade ago when asset prices benefited from ongoing total economic growth and moderating inflation, while the lower strata bear the burden of multiple years of higher prices. For a while excess savings built up during the pandemic cushioned the impact. But whether one looks at net savings, the rate of savings, the surge in unpaid credit card balances, or the default rate on car loans, it is apparent that there aren’t any excess savings left. The cushion is gone.
We are in a political season. One doesn’t have to be a political scientist to understand the core issues that will decide this fall’s winner. As always, at the top is each voter’s economic situation. Is he or she better off that four years ago? The simple answer is that some are and some aren’t. There has been a lot of attention paid to poll data suggesting the Republicans are making inroads with black and Hispanic voters. To many, that’s a head scratcher given their past voting records favoring Democratic candidates and President Biden’s urge to improve their economic condition. Forgiving student loans would seem to be a big plus, but only for those with forgiven student debt. Many hardworking minorities never went to college. They simply find costs have risen faster than wages. That explains the poll results.
But it doesn’t stop the current administration from trying to make a difference. With a Congress unable to agree on almost anything, the remaining pathway toward relief would appear to be Executive Orders and regulations directed to creating more economic balance. Executive Orders are limited in scope and likely won’t last beyond the current President. When Mr. Biden’s term is up, his successor will likely unwind much of his Executive Orders just as he did when he took office, and as Donald Trump did four years earlier. Thus, many if not most Executive Orders have a half-life of four years or less, hardly an environment that encourages long-term investment.
While all administrations impose their own set of regulations, the current Biden administration has gone on a regulatory binge. Depending who’s counting, it appears that there have been 10-15 new regulations for every one that was eliminated. Eliminated is probably the wrong word as most of the deleted regulations are simply ones superseded by new ones.
As a former research analyst, I sometimes note that the hedge clause of small type that no one reads was a short paragraph when I started in the business decades ago. Today, that clause, depending on the firm and its lawyers, can run four pages or more. And they still go unread. Fortunately, since most now read analyst reports online, we haven’t needed to defoliate more forests to accommodate the larger hedge clauses.
Most of the regulations are either designed fixes for perceived economic imbalances or other steps designed to alter the impact of laws, or the balance of supply and demand. While some succeed, others have unintended consequences. Look at homeowner and auto insurance. Progressives claim the higher premiums are a function of price gauging. Yes, it’s an election year. Indeed, insurer profit margins over the past 12 months are higher. But looking out over a longer period, that isn’t the case. The logical argument is that insurers are catching up for all the cost increases they have incurred. Since the pandemic, used car prices, for instance, are up 30%. The costs to repair have risen even faster. In most states, regulators must approve rates. If insurers can’t offset higher costs, they leave and go elsewhere. In a capitalist democracy, government can’t force private insurers to stay. In Florida, a government sponsored entity is now the largest homeowner insurer as private companies subject to the costs of climate change, inflation and regulation either have to raise rates by a shocking amount or leave the state. Florida, lying in the path of hurricanes escapes sometimes and gets whacked others. Widespread damage quickly escalates the number of lawsuits. In 2022 alone, a particular bad hurricane season, there were more damage suits filed in Florida than in the other 49 states combined. Those costs are built into future premiums. The state-sponsored insurer incorporates provisions that limit lawsuits.
Where does this all lead? The reality is that in attempting to help the little guy, the burden of legal and regulatory costs are hurting the economically challenged as much or more than the rest of us. The most pinched are small businesses. By small I mean not only the family that runs a local bodega, but also the entrepreneurial company that wants to go public someday. One reason we see so few new companies coming public is that the cost of going public and being a public company have gotten prohibitive for most. It isn’t for lack of investor willingness to invest in young untested companies. One only has to look at the worlds of cryptocurrency and meme stocks to see the obvious. Now the government wants to slow or stop roll ups whereby an entity buys small industry participants to gain scale. Does having more viable competitors but fewer total competitors heighten or reduce competition?
For centuries, industrial revolutions have enticed hundreds, even thousands of companies to try and find their pot of gold. A century ago, more than 3,000 companies wanted to become a force in a new automotive industry. A half century ago, cable TV franchises were handed out at the township level, often to friends or family. In the early 1980s, dozens tried to build personal computers. This past decade saw dozens try to enter the EV industry. Today hundreds of new names have the letters AI in their title. Most will fail. But revolution gives birth to General Motors, Ford, Dell, IBM, Tesla and OpenAI. Eventually, the new giants give way to the next revolution. Where are Sears or Kodak today?
Trying to bring this all to conclusion, the toxic impact of inflation caused by government intervention (lower interest rates and too much fiscal largesse) is showing up everywhere. The fix is not more lower rates or more fiscal largesse. Nor is it more regulation. It’s letting the natural order of supply and demand work with some regulatory oversight to control abuses.
It may seem a worthy political move to announce steps to regulate prices, limit mergers, or blame business greed for all the problems. But voters aren’t that naïve. They will go to the polls and do what they always do. Vote with their wallets. For some, rising stock prices, higher interest rates on savings, and improved home values will say “let’s stick with what we’ve got”. For others, choked by the costs of inflation, or who suffered under regulatory burden, the answer will be to vote for change. Sure, other issues like immigration and abortion matter. For some, one or both of the above will be the primary motivator for their choice. But for most, the wallet takes precedence. Most voters don’t know what GDP even stands for let alone what it means.
The message of the stock market at the moment is that either Biden or Trump will be OK assuming neither gains enough control in Congress to make major legislative changes. That could change post-Labor Day if the outcome becomes more conclusive. But for now, investors remember 4 good years under Trump and 4 good years under Biden interrupted briefly by a pandemic unlikely to repeat itself. But the stock market today only deals with the economic bifurcation around the edges, the lackluster performance of the dollar stores or the slow growth of manufacturing. I don’t expect the summer political conventions to make much difference. In reality, given the lack of competition within each party, they are likely to be ignored by most. In the meantime, as excess savings are used up, we will face a new reality whereby all of us will have to allocate capital differently. Changes in how consumers and businesses spend will dictate a new economic direction forcing us to adapt. Interesting times.
Today Alphabet CEO Sundar Pichai turns 52.
James M. Meyer, CFA 610-260-2220