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Predicting the future!

Predicting the future!

February 24, 2022

Predicting the future!

By Peter T. Waldron

Managing Partner of Waldron Partners

“A person often meets his destiny on the road he took to avoid it.” Jean de La Fontaine

                As a culture we are captivated by the noise of chaos. We are not satisfied with the plain or simple. We need to move, shake, and change our environment, often forgetting a safety net to catch us when we fall. We are enchanted by exciting fantasies, unconcerned with the unpredictable reality. This has never been more prevalent than in the last eighteen months. We went through a global pandemic that nearly crippled our world economy, which we then consequently saw our government print an unprecedented amount of money that drove the market to historic highs. Now, we are seeing positive signs for recovery, the market has continued to grow and we are becoming acquainted with the reality of inflation. Collectively, we adhere to every headline and are held in paranoid ecstasy. While the paranoia has been slowing diminishing from this year’s activities, many do not fully understand the impact the current economic influences have on their wealth. Many are lost in the question of what will happen in the future to inflation, taxes, and interest rates.

                Believing in wizardry or whimsical fairytales is fun for children, but ascribing to math, principled debate, and good old-fashioned logic results in more definitive outcomes. While predicting the future is a fool’s game, you can still use some helpful economic tools to understand what is happing around you. Our very own investment lead, Troy Rouleau, presented our team with one of those tools, the Ibbotson-Chen Model, which is a macroeconomic model for the equity risk premium. {ERP=(1+i)*(1+rEg)*(1+Peg)-1+Y-RF }---[ i = inflation / rEg = expected real growth in earnings per share / Peg = expected change in P/E ratio / Y = expected yield on the index / RF = risk free rate]. In simple translation, you should be compensated for the risk of investing in equities (stocks) with inflation as a direct correlation to your success. In general, inflation will drive equity returns up. However, despite the potentially positive correlation, there are extreme examples (e.g. Venezuela, 1920’s Germany) where hyper inflation stymies economic production and would hurt your stock portfolio.

While inflation contributes to both fiscal and monetary policies of our government, fiscal policies have most, if not all, the influence on taxes. The impact taxes pertain on your wealth is felt every day, but potential changes in estate and income taxation could cause the impacts to become burdensome. It is too soon to begin planning for the upcoming modifications to our laws, primarily because they have not been instated, but when the government finalizes these changes, you should consider reviewing your planning. That said, the two main changes will come in the form of an increased level of income taxation, higher rates on income and capital gains, and an estate tax. The estate tax could be a death blow to many people’s wealth; The adjustment could reduce the allowed exemptions, which is the amount you can pass free of tax and increase the rate of the tax. Additionally, it is important to note that increased taxation can reduce both inflation and market growth. Understanding these proposed changes and being aware as they come to fruition allows you to address the impact these new laws have on your personal financial situation. 

                The monetary policy in our country is dictated by the Federal Reserve Bank which has three main tools to influence the economy. The three tools are reserve requirements (the amount of cash a bank is required to keep on hand), the discount rate (the amount the bank charges its member banks to borrow), and open market operations (buying/selling bonds). These three activities can directly influence inflation and interest rates. One common concern is holding bonds and stocks during a rising interest rate environment and how it will impact the prices of bonds and reduce economic growth. While we will never know exactly what the FED will change, we can understand what is currently known, which is that the rate of cash reserved at member banks is 300% greater than 2009. While this doesn’t tell you a lot about the future, it does tell you that banks are much more secure than before.

                Predicting the outcomes of everything discussed in this article would be a feat of magic and while magic is a fun distraction, it is probably best saved for kids’ birthday parties. Allocating your time to understanding what you have and how inflation, taxation, and interest rates impacts it would yield better results. Times like these are when individuals turn to a professional for advice who spend their careers learning and practicing their craft to ensure they provide unbiased knowledge to fit the unique needs of each client. Regardless, predicting the future holds minuscule importance as opposed to escaping our paranoid ecstasy in order to build a plan for the future that is the balance in a world of chaos.

“You can't connect 0the dots looking forward; you can only connect them looking backwards. So, you have to trust that the dots will somehow connect in your future. You have to trust in something - your gut, destiny, life, karma, whatever. This approach has never let me down, and it has made all the difference in my life.” - Steve Jobs


Peter T. Waldron: California Insurance License #0E47827

Peter T. Waldron is a registered representative of Lincoln Financial Advisors, a broker/dealer, member SIPC, and offers investment advisory services through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor, Waldron Partners, 3201 Danville Blvd., Suite 190 PO Box 528, Alamo, CA 94507.  Waldron Partners is not an affiliate of Lincoln Financial Advisors. Insurance is offered through Lincoln Marketing and Insurance Agency, LLC and Lincoln Associates Insurance Agency, Inc. and other fine companies.  This material is for use with the general public and is designed for informational or educational purposes only.  It is not intended as legal, tax or direct investment advice. Lincoln Financial Advisors does not offer legal or tax advice.  CRN-3647129-062421