Smart Investing with Brent & Chase Wilsey
Business:Investing
September 7, 2024 | The labor market, Economy, Price Gouging, Roth Conversions, DraftKings Inc. (DKNG), Dollar General Corporation (DG) & Dell Technologies (DELL)
The labor market continues to soften
The Job Openings and Labor Turnover Survey (JOLTs) showed job openings continued to fall across the country in the month of July. It was reported that available positions fell to 7.67 million in the month, which 237,000 lower than June’s downwardly revised number and well below the estimate of 8.1 million. While this marked the lowest level since January 2021, there were still close to 1.1 job openings per available worker. I do believe we still have some room left for normalization before these declines in job openings becomes problematic. This news also caused the relationship between the 10- and 2-year Treasury yield to uninvert for the first time since June 2022. Generally long-term rates are higher than short term rates and I believe we will see the yield curve continue to steepen as the Fed cuts rates. While the curve usually reverts before a recession hits, I still believe we aren’t heading towards a problematic recession in the coming months.
The labor market is definitely slowing
Nonfarm payrolls increased by 142,000 in the month of August, which was up from 89,000 in July, but below the estimate of 161,000. Both June and July also saw downward revisions, which totaled a substantial 86,000. Leisure and hospitality (+46K), healthcare and social assistance (+44.1K), construction (+34K), and government (+24K) led the way for job gains in the month. Manufacturing (-24K), retail trade (-11.1K), information (-7K), and utilities (-200) all subtracted jobs from the headline number. I was also surprised to see professional and business services only create 8K jobs in the month and I believe that is a good indicator that the economy is definitely in a slowdown. While the numbers don’t look great, I still believe there is no cause for major concern at this point. With an unemployment rate of 4.2% and the major gains we saw coming out of Covid, it was unlikely we’d see that type of labor market continue. I still believe it’s possible we see a soft landing, but in that scenario, you wouldn’t see major payroll gains every month and the prints would likely be more muted and even softer than the readings we have seen the last few months. My expectation is for the Fed to cut rates by 0.25% at the September meeting followed by cuts of 0.25% at both the November and December meetings.
The economy is getting back to normal
It may feel like the economy is weak, but I believe that is because we are comparing it to an excessive economy that had too much money floating around and people spending it pretty much on anything they wanted while not caring about how much they paid. Now that extra cash is gone and we’re back to normal. That might feel uncomfortable for some people as they now can’t spend so easily on things like luxury items. Proof of this can be seen in the used luxury watch market which was very hot, but has now seen prices fall over the last 9 quarters because the demand is gone. I don’t care if you’re buying stocks, homes, or luxury items, if you overpay during the hype, you’ll probably end up losing money down the road. I believe it’s always best to buy things on sale, even if that means being patient for a few years.
There’s a lot of talk about company’s price gouging, but the numbers tell a different story!
There is no doubt that with inflation, prices for many items have increased over the last five years. But are businesses taking advantage of these higher prices to increase their profit margins? Looking at just the companies in the S&P 500, the average price markup between the selling price and the cost is 54%. That compares to 51% five years ago. According to research from financial company Bloomberg, they say the grocery business markup is actually down from five years ago and when looking at the average profit margins for grocery stores, it is now 0.3% lower than five years ago. You may not like the information because we want to blame somebody for paying higher prices, but based on these numbers companies are not price gouging. We do believe every business has a right to make a decent profit for being in business, but the free market and competition should eliminate price gauging and keep the market balanced.
How the Time Value of Money Impacts Roth Conversions
When you do a Roth conversion, the amount you convert into a Roth account is taxable when you do it. First, this means you are paying taxes now that you didn’t need to. Second, the question people have is, “If I don’t pay that tax now and instead got to keep those dollars invested, what would that grow to and does that offset the benefit of doing the conversion?” In other words, is having extra tax-free money in the future worth paying taxes now when considering the time value of money? Time value of money is the concept that dollars today are more valuable than dollars in the future because dollars today may be invested and grow over time while dollars in the future are worth less due to inflation. This is an extremely important concept and needs to be considered when making almost all financial decisions from Social Security to paying debt to investing in general. However, when it comes to Roth conversions this should not be considered. For example, let’s consider someone making a $50,000 Roth conversion who is in the 20% bracket and will be for the rest of their life. On that conversion they will owe $10,000 in taxes (20%) meaning the remaining $40,000 makes it into the Roth account. Money in a pre-tax account and a Roth may be invested exactly the same so we’ll assume an 8% compounded return. After 10 years, the $40,000 in the Roth grows to $86,357, which is all tax free. The question though is what would that $10,000 have grown to if it didn’t have to be paid 10 years prior? Well, if no conversion was done, all $50,000 would have remained in a pre-tax account growing at the same 8%, so after 10 years it would be worth $107,946.25, obviously more than the $86,357 in a Roth. However, that $107k has not yet been taxed so if accessing it still costs the same 20% tax that would be $21,589.25, meaning the after-tax amount is… $86,357 or the exact same as we would have in the Roth. What this means from a time value of money perspective is, since pre-tax and Roth accounts may have identical investments and returns, the present value of the tax on the conversion is the same as the future value of the tax if there is no conversion, assuming the tax rate is the same. In our example the future value of $10,000 is $21,589.25 assuming an 8% return over 10 years, which is true. Therefore, when considering a Roth conversion, it is not the time value of money that is relevant, but the tax rate during the conversion compared to the tax rate in the future. In our example we assumed a consistent 20% tax rate which is not realistic. Over time income levels and sources change as well as the tax rates themselves. If Roth conversions are performed when the individual tax rate is lower than it will be when pre-tax retirement withdrawals are being taken, the conversion is helpful. For instance, if we think our retirement tax rate will be more than 20%, a conversion should be done now if it is 20%.
Companies Discussed: DraftKings Inc. (DKNG), Dollar General Corporation (DG) & Dell Technologies (DELL)
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