Banks and the Economy
Each quarter we get very excited to see what the major banks have to say about the consumer and the economy. Last Friday, JPMorgan, Wells Fargo, Bank of America and Citigroup all reported earnings. The overall comments were the consumer is still strong. The CEO of Wells Fargo said average deposit balances per customer remain above 2019 levels and loans to businesses were up in the quarter. There were some write-offs on commercial office buildings with Bank of America charging off the most at $100 million. In total the four banks charged off $6.6 billion of all loans which was double what it was one year ago. Profits for the four banks in the fourth quarter were up 11% from one year ago coming in at $104 billion. JP Morgan Chase accounted for roughly half of that profit with $50 billion in the quarter. These profits are pretty amazing because in addition to the $6.6 billion charge off for loans, they also had to set aside $9 billion to pay a special Federal Deposit Insurance Corporation (FDIC) fee which was related to the failures of Silicon Valley Bank and Signature Bank. So, I’m happy with the report and do continue to believe 2024 will be a good year for the economy and the consumer, but as always, we will receive our bumps and bruises as the year progresses.
Office Space
It was reported that 19.6% of office space in major US cities was sitting empty in the fourth quarter of 2023. That is the highest number on record which goes back to 1979. The problem is twofold. First, there are still some people working exclusively from home, which I still say as time passes more people will be coming into the office as businesses need to increase their profits and productivity. Second, overbuilding occurred for years with commercial buildings. It was noted that the bulk of the vacant space in buildings were built from the 1950s through the 1980s. If you’re going to get an employee to come back to the office, they don’t want to go back to some rundown building. They are asking for beautiful buildings with coffee bars, gyms, and Pickleball courts. There are some good opportunities for investments in class A commercial buildings that are in booming areas, but investors have to be wary that they are not investing in lower grade class B or C buildings in run down cities.
Consumer Spending
I think someone forgot to tell consumers to slow down on spending. Retail sales were strong in December as they grew 0.6% for the month, which topped the estimate of 0.4%. Looking compared to last year, December sales were up an impressive 5.6%. Areas of strength included food services and drinking places (+11.1%), non-store retailers (+9.7%), and electronics and appliance stores (+10.7%). Areas that weighed on the report included gas stations (-6.6%), furniture and home furnishing stores (-4.7%), and building material & garden equipment & supplies dealers (-2.3%). While this is good news and shows the consumer is still strong, it is leading to concern around the Fed’s rate cut path. I’m still optimistic the Fed can balance the economy and rate cuts to navigate a soft landing.
Electric Car Rentals
In 2021, Hertz had a big push to add electric vehicles to its fleet with talk of eventually buying 100,000 Tesla’s. Three years later, they are now selling 20,000 electric vehicles and will take a $245 million net depreciation expense. They discovered that the excitement for electric vehicles was not what they anticipated and have now backed away from the previous goal to have a quarter of their fleet in electric vehicles by December 2024. They also mentioned that repair costs on electric vehicles have cost them more and they will go back to purchasing internal combustion engine vehicles. If you’re interested in getting a good deal on an electric vehicle, you may find some good prices on the Hertz website as they try to unload those 20,000 vehicles.
Investing in China
I remember back in 2019 when people were excited about investing in China and were looking forward to some big gains. I had concerns because of things I had read about China and also as I have said many times, they are a communist country which means it is controlled by the government. Fast-forward to today and the five-year return on the Hang Seng index is a loss of around 40%. Unfortunately, I don’t see it getting any better soon. Some of the negatives I see going forward in China include rising youth unemployment, the government is tightening control on many financial relations, and on top of that they are restricting some travel and spending abroad. It never made sense to me to invest in an economy that is controlled by the government. We may have our troubles here in the United States, but with a free economy an investor can still get some good returns by investing in the right companies here in the US.
Red Sea
There could be a disruptor in the slowdown of inflation in the first quarter due to the attacks by Yemen Houthis on ships in the Red Sea. Let me be honest I really did not know who or what these people are fighting for. They are considered a large clan originating from Yemen’s Northwestern Saada province. They are doing these attacks to support the Palestinian people in Gaza. The reason this could have an effect on inflation is that ships have been rerouted to avoid confrontation with them. The new route they are taking now takes nearly twice as long at 92 days versus 48 days for the old route. In addition to the added cost for labor for the men on the ship and the higher fuel cost and maintenance on the ships, the ships won’t get back as quickly to pick up another load, which means many goods will be stuck in the ports. As the goods are not shipped out, supply will shrink and prices will likely rise. Hopefully the situation will be resolved soon and it will not upset the flow of goods which would likely lead to an increase in prices.
Insurance Companies
Great news from New York and California as they are allowing insurance companies to boost their rates on autos and homes anywhere from 15 to 30%. You may be thinking wait a minute that’s not good news. I believe it is for two reasons. First, insurance companies stopped writing new business in some states, so consumers could not get any insurance. Second, consumers will have to sharpen their skills to shop around for insurance because now with higher rates of insurance, more companies will be coming in to write insurance and competition will bring down prices. Don’t think that premiums will come down to where they were years ago, you have to remember you’re paying much more for cars and homes these days and therefore the cost of insurance will be higher. Insurance companies are not ripping you off, US property and casualty insurance companies had about $32 billion in underwriting losses in the first nine months of 2023. This was roughly a 30% increase from the previous year. Just to reemphasize, the good news is you can get insurance, the bad news you’re going to pay more for it. But when your insurance comes up for renewal, be a smart consumer and spend a good amount of time shopping many different companies because there will be more companies offering insurance and deals to consumers to acquire new customers.
Rate Cuts
I’m sure you’ve heard by now that at Wilsey Asset Management we expect to see three if not four rate cuts by the Federal Reserve this year starting in June or so. There will be effects that will appear negative, but are not. One of the biggest affects you will see is a decline in the US dollar. At first glance this seems like a negative, but there are some positives to a decline in the US dollar. First off, it makes our exports less expensive for foreigners to buy, which means we can produce more to sell. For foreign travelers it also gives them a better cost on traveling here to the US to our many beautiful tourist attraction sites across the country. This would lead to foreigners spending vacation dollars and adding to our GDP. The other is a negative/positive as it will make foreign goods more expensive for us to buy here in the US. This could lead the consumer to realize the cost difference and perhaps not buy foreign goods, but look at goods made in the USA as a better option instead.
Oil Price
I was so excited when I paid $4.25 for the credit price on a gallon of gas at an Arco station recently. We know that the price of oil is down, but history tells us this won’t last. Investors exposure to energy in November was 4% more exposure than their benchmarks and then fell to 11% less exposure just one month later in December. Now we all know we’re supposed to buy low and sell high, but the trend always seems to do the opposite. I can’t tell you when oil will rebound and to be frank I am surprised where it is today with the turmoil in the Middle East. There is currently an abundant supply of oil worldwide and something down the road will change that. If you don’t have some energy in your portfolio, you may want to consider looking around for a good equity or two to add to your portfolio. As always, remember to be patient as it could take many months for oil to come back in price, but when that happens, you will be rewarded and, in the meantime, you may be collecting a decent dividend.
Leaving California
The numbers are in from the Internal Revenue Service and they show the state of California lost $29.1 billion in adjusted gross income from people leaving the state in 2021. To put that number in perspective that is three times the amount of the population that left in 2019. What is even more concerning is 40,000 residents with graduate or professional degrees from 2020 to 2022 left the state on a net basis. One would think with a $68 billion shortfall for the upcoming budget that politicians would wake up and smell the coffee. Unfortunately, that is not the case for 2024 as California’s top marginal tax rate on wages is now going to be 14.4% because of a law signed by Governor Newsom that removed the $145,600 wage limit for a 1.1% payroll tax. Apparently, this will be to expand paid family leave.
Financial Planning: Taxes When Selling a Home
A house is considered a capital asset, and when a capital asset is sold for a profit, a capital gain is produced which can result in a tax bill. For homes that have been the primary residence of the seller for at least two years out of the last 5 years, a home sale exclusion applies which reduces the amount of capital gain by up to $500k for a married couple or $250k for a single person. For example, if a home was purchased for $250k then sold years later for $1,250,000, there would be a capital gain of $1,000,000. This gain may then be reduced by the $500k exclusion, resulting in a taxable capital gain on the remaining $500k. If the home was instead sold for $700k after purchasing for $250k, the gain would only be $450k, which the exclusion would completely cover resulting in no taxes on the sale. If there is a taxable capital gain after the exclusion, it will be taxable at the lower capital gain rate as opposed to ordinary income rates on the federal side. On the state side the gain will be taxed as ordinary income as most states don’t have separate capital gain tax brackets. For married couples with an adjusted gross income of about $125k or less, including any taxable gains from a home sale, the federal capital gain tax rate is 0%. So, if a residence is going to be sold, it would be best to sell during a year with low income such as the first year of retirement so that the 0% tax bracket would absorb some of the gain. Once income goes above $125k, the next capital gain bracket is 15% up to an income level of about $615k at which point the tax rate increases to 20%. It is also important to keep a record of any home improvements or selling costs as these can be deducted against the taxable gain. Due to appreciation in the housing market, it is getting more common for home sales to result in taxes, so be diligent about keeping records and be careful when you sell a home so you don’t pay more taxes than necessary.