The Three Big Shifts That Will Change Business

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I see 3 major changes coming for businesses over the next few years:

1. Higher and more variable inflation

2. Higher labor costs and fewer employees

3. Higher taxes

The result will be lower returns and multiples for business going forward. In my view the value of almost all assets (real estate, stocks, bonds, private equity, etc.) will deflate from the heady days of the last decade and a half.

It won’t happen all at once and the nominal value of them might not go down but the real value when measured against inflation will erode over several long grinding years.

Inflation

We just lived through a bout of higher inflation that has mitigated but I think there is more to come. Some economists see inflation moving in long (roughly forty year) cycles. As you can see in the chart below, we had increasing inflation from World War 2 until it peaked in the late 1970s/early 1980s and then a long cycle of disinflation since then.

Check out the date at the very top reading: 1980. We are roughly 40 years from that peak. That would lead you to believe that the uptick in the early 2020s is the beginning of a new cycle back up.

It’ll be driven by increasing de-globalization due to our increasing competition with China; the need to re-shore some critical supply chains and key technologies like semiconductors; and by the need to keep high deficits to provide benefits to increasing numbers of retirees.

A final factor will be the government itself. I will explain the concept of financial repression in other posts but for now just accept that the government has multiple ways to force institutions/people to buy its debt at rates that are below the rate of inflation.

As a result, the government can slowly bring down the its debt to GDP ratio without making harsh cuts to spending. We did it post WW2 and we are doing it again now but it requires inflation rates above what we’ve seen in several decades.

Higher Labor Costs

Labor is going to cost more period. Rs will want to restrict immigration and Dems will want to increase employee-related regulation. Both parties seem to want to push up wages so I think that is what will happen but the exact form will be part of the back and forth between the parties as they reform their coalitions.

I don’t see Democrats being able to maintain high levels of immigration in the future, especially not illegal immigration, so that source of workers will be reduced.

We just aren’t producing enough children domestically to continue to grow the workforce. Last time I checked it took 30 years to make a 30 year old and we aren’t getting it done.

Higher Taxes

Taxes will take a little longer to hit in my view but there’s no way we can keep increasing our deficits at anything like the rate of the last few years. We also aren’t going to cut benefits for older Americans so something will have to give.

It’ll be tax rates that succumb in the end but my guess is this is still a campaign cycle or two away. Trump has been dedicated to cutting corporate taxes but his choice of running mate signals a potential new direction. JD Vance or someone like him will be more open to raising rates on large, multinational businesses and I don’t think they view the middle class as people who make up to $400,000 a year.

If the Democrat wins, taxes will go up sooner but the chances of both Houses of Congress going Dem are low so I think the increases will be blunted. In the long run, I see large business joining the professional class as a core Democratic constituency. The result will be higher taxes on the wealth, privately held smaller businesses, and pass through corporations.

An indication of this was the recently proposed wealth tax from the Biden Administration. While the proposal hasn’t been laid out in detail, it seems to increase taxes on individuals rather than corporations themselves.

With both parties, I also think we’ll see tax policy get much more prescriptive based on government priorities. Dems will give lots of tax breaks for green energy and Rs will do it for manufacturing and potentially fossil fuels and there’ll be many shades in between.

In the end, these trends are going to have good and bad effects but they will create a much different future than most of us have lived through. The results will probably be pretty good for domestic workers who will see their wages increase above the rate of inflation. It’ll also reward companies investing in the areas of national need or using government incentives.

Overall though, I do think it means a squeezing of valuations. Your company won’t exit for the same EBITDA multiple, your house won’t appreciate as much, etc. but similarly your acquisition or second home purchase won’t cost quite as much either.

Keep growing,

Alan

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