Stagflation: Everyone's Favorite Portmanteau

Stagflation: Everyone's Favorite Portmanteau

It turns out that if you have a raging inferno, using gasoline to extinguish it is not necessarily the best way to put it out.  Why would that be?  Well, and bear with me here I’m no scientician, gasoline is combustible.  

So then why would the Congress pass an enormous spending bill when the last several have lit the economy on fire?  Well, the Congress apparently only knows how to spend.  Most of the spending is aimed at green energy subsidies, prescription drug reforms, and IRS tax code enforcement (ironically named the Inflation Reduction Act) for $430 billion.  Additionally a separate bill was used to subsidize manufacturing semiconductors in the US about $24 billion along with tax credits.  Although this is spending for the benefit of national security, another $200 billion is being spent on research and development.  The problem with both of these spending bills is that the value of the dollar is decreasing relative to its purchasing power (aka inflation).  

But there’s a sinister part of these bills that is being overlooked.  The Inflation Reduction Act will raise the corporate minimum tax rate to 15%.  Meaning that companies will ensure companies pay a 15% of taxes on all profits regardless of tax credits.  The impact of all taxation is that companies will pass along the costs to end users (think raising prices).

Figure 1.   An accurate representation of the US Economy right now.  

The other consequence when prices rise for corporations is that they will cut jobs and reduce spending.  While this has some benefits for reducing the inflationary pressure, it also has the impact of reducing growth.  The stagflation (inflation + stagnant growth) is a sinister problem.  

So what does all this mean for investors? In many ways nothing changes about how we invest.  We should still look for great businesses that sell for less than their value in the market.  The better businesses will be able to weather any storm we throw at it.   But we should be prepared to keep looking for these great businesses because we may not have seen the bottom yet.  

It also means that now maybe a good time to look at buying whole businesses.  Most investors don’t have the confidence to do so, but owning an entire business allows the owner to distribute the cash flow as he sees fit.  Many closely held businesses will be sold so the owner can take a profit and retire, and with the market where it is, an entire business can be had for much cheaper than even 6 months ago.   Something to think about that goes beyond our normal discussions about the market

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