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Inflation, Retiring Abroad and a Changed Climate

Dear Clients and Friends,

Stock indices grinded higher in the 2nd quarter, although the most speculative corners of the market have come under pressure since early June. In the crypto world, Ethereum was flat during the quarter, bitcoin was off 40% and the basket of 37 meme stocks tracked by Goldman Sachs has recently entered bear market territory, having given back more than 20% since peaking in June. The retracement in these speculative assets is not necessarily a cause for immediate concern, however. I believe that a strong economy supported by pent up consumer demand and fiscal & monetary stimulus, lowers the chance of contagion, though it bears watching.

A key insight I missed earlier in the meme stock saga, is that if the investor base in a (meme) stock is comprised of people of a singular tribe – in the case of AMC Holdings, self-described “Apes” – there is no price discovery taking place. In other words, the price has no meaning in the traditional sense that an analyst views a stock price as a consensus view of the market. So, saying it is overvalued or irrationally priced is not relevant nor necessarily true, because the stock has left one universe that abides by certain rules and has entered a parallel universe that is not governed by those rules. So, to be successful in meme stocks, it is not necessary or even helpful to have an investment background. What is clear though, is that while the ingredients for success are hard to distill, the recipe for disaster is very clear: the potential for these stocks to literally come back to earth and burn up your money upon re-entry.

Inflation is a trending topic as the economy reopens and is often misunderstood. Much like crime statistics, we tend to overinterpret recent and local experiences. If my neighbors on the Nextdoor app are to be believed, crime is exploding (and has been exploding since I joined the app 7 years ago). The reality, however, is that violent crime dropped by 50% (FBI) or possibly 75% (Department of Justice Statistics) and property crimes saw a similar drop, between 1993 and 2019, the latest year for which data is available. So, back to inflation, are we missing the bigger picture here and are price increases much lower than they once were?

Is inflation high or just less low?
 Is inflation high or just less low?

Historically, I have shied away from discussing inflation in my newsletters, for fear of boring my readers. That it has been a boring topic, however, is also a wonderful tribute to the fact that US inflation has been so benign for decades. In the 1970s, inflation was not boring in this country, nor in Germany in the 1920s or in the more recent past in parts of South America and Africa. 

Inflation is a bit little less boring today and of course people genuinely wonder and worry whether higher prices are here to stay, myself included. The consensus view is that inflation is transitory. The stop-start process that the global economy has gone through because of the pandemic, has led to supply shortages and pent-up demand. In essence, inflation is demand exceeding supply as a result of an economy that cannot produce enough goods because it is at capacity.

However, when prices go up for a sustained period of time, future price increases become entrenched in people’s minds and inflation turns into a self-fulfilling prophecy: retail businesses demand higher prices from their customers, suppliers demand higher prices for their goods & materials, workers demand higher prices for their labor, landlords for their rents, and so on and so forth, in an attempt to pass on expected cost increases. Thus, the key question to ask is indeed whether the inflation is transitory or not. The longer it sticks around, the more likely it becomes entrenched in expectations, and the more likely it is to persist.

Some price hikes are pandemic-related and thus transitory: raw material prices for new home construction, used car prices due to the chip shortage, rental car prices, and possibly airline fares. Moreover, part of the inflation is what is referred to as reflation, i.e. getting back to pre-pandemic levels. However, that does not explain all of it and it is certainly true that the massive fiscal and monetary support to get the US economy through the pandemic is unprecedented in US peacetime history. Thus, a situation in which the Federal Reserve loses control of price stability is not beyond the realm of conceivable unintended consequences. 

How to position your portfolio for (unexpected) inflation? Stocks and real estate tend to hold up well, bonds tend to perform poorly, gold could be a consideration, though it is volatile and not reliably protective unless you have a long-term horizon. It is also important to note that stocks and real estate will not provide inflation protection in a scenario where inflation surprises too much to the upside and price increases become disorderly. I do not think the portfolios we manage need major retooling for inflation at this juncture, given that we own a healthy dose of inflation resistant assets. And as to inflation itself, I am willing to believe the consensus that it is transitory. However, if that term is still used 6 months from now, it may not be so transitory.

How to retire abroad and 10 years early, is the topic of my inaugural podcast and I thought it was newsletter worthy. It is a topic that is top of mind for some of my clients as they approach retirement age. I am usually asked either how to retire abroad or how to retire early, but I am combining them, because one of the beauties of retiring abroad for many people ends up being the ability to retire early as well.

Before we get into the “retire abroad part,” let us explore the “retire early” part in isolation. How soon can you retire? You may have heard of the 4% rule. The idea is that if you can fund your retirement without redeeming more than 4% of your portfolio per year, that it will sustain itself indefinitely. Say you had only 2 sources of retirement income, which is fairly typical: social security and your investment portfolio and that you needed $100,000 from your investment portfolio to supplement the part of your pre-tax budget that is not covered by social security. In that example, we equate 4% to $100,000 and so your portfolio would need to be 25 times $100,000 or $2.5 million to fund your retirement.

Many people then back into their retirement date from there. For example, if you are 55 and you have $1.25 million, you might need to work another 6-10 years to get to $2.5 million, assuming a 5-7% return and some additional savings. But what about not sacrificing time and savings, but rather your retirement budget? Fewer people approach it this way, but what if you said: “I want to retire now, so how can I make $1.25 million work for me?”

I am going to pivot to the “retiring abroad piece”, but even if you do not wish to retire abroad, it is a helpful exercise to reassess how much is enough. Perhaps you do not need to work as long as you had assumed, if you do not so desire.

The first observation about retiring abroad, is that there is no one playbook to follow, each situation is truly unique to the person/couple and their desires, resources, and concerns. I will touch on some of the common topics and questions that come up when people start to seriously consider retiring abroad.

Word cloud
 What is on your mind?

1. Can I collect Social Security Abroad? – The simple answer is yes. Not only is it very easy these days to move money across borders electronically, one can also receive social security in almost any country if you are a US citizen. It is a little bit more complicated if you are not.

2. Healthcare – The main concern will be the quality of healthcare in your chosen country. The cost will most likely be less than what you would face if you retired in the US with Medicare. To apply for Medicare, you have to be a US resident. If you do not apply for Medicare when eligible – which some overseas retirees opt for – you could potentially face a 10% penalty upon your return for double the amount of years you were eligible but did not take Medicare. Most likely, you will get the penalty waived if you enroll as soon as eligible once you return to the US. But even with the penalty, you would probably come out ahead by having foregone the Medicare premiums while abroad. To be sure, some retirees will opt for Medicare enrollment – and use a US address for processing the paperwork – as a form of double insurance or a US medical safety net, if cost is not an issue.

3. Residency – Another key aspect of retiring abroad to sort out, is residency. I am most familiar with Europe, so I will speak specifically to that. But in general, I would say establishing residency is a combination of jumping through some bureaucratic hoops and being able to demonstrate you have the required financial means. This is not a process that people typically fail at, so it just becomes a matter of doing it. 

For example, In the case of Spain, first you apply for a 1-year residency that you can then renew into a 2-year residency upon expiration. The nice thing about the initial residency is that you can apply at the Spanish consulate in the US, which is easier at some level, as they are used to dealing with you and in the English language. The renewal is probably a little bit harder, because now you are in Spain, but not exceedingly so. As far as financial means, for the 2-year residency permit you only need to be able to show you have the cash to support yourself for 2 years, which for a single person comes out at about $55,000 euros. You may have to get some things notarized and translated but these hurdles should not be too high to scale.

4. Buy v rent – I advise you look at this issue differently than maybe you have traditionally done.  In the United States many of us have been told our entire lives that homeownership is the primary way to build wealth. I have some question marks that I attach to this narrative, but that is a topic for a different day.  When you retire, however, you are not moving overseas to build wealth, but rather to enjoy life. Of course, the nicer neighborhoods or more up-to-date properties will also be the pricier ones, and why sacrifice more years of your life to live in an up-and-coming area or a fixer upper, or live on a reduced budget, if that is the buy vs. rent tradeoff for you. 

You will also not be able to get the same size mortgage from a loan-to-value perspective that you may be able to get in the US. Additionally, the mortgage process is much different, and banks offer incentives to their customers to use their mortgage product, so you are not just shopping around for the lowest rate, but also for the perks.

5. What do you do with your investment portfolio? – Your portfolio should be a little different than if you retired in the US. The main difference would be that your liabilities are in a foreign currency and a foreign economy so more of your assets should be exposed to that currency and economy. The reason that is important is straightforward: say the euro goes on a tear vs the dollar and your rent is in euros, this will be a risk to you if you do not have significant euro exposure in your portfolio. Similarly, if the euro economy really wakes up and the US economy slows down, your European stocks will appreciate and your US stocks will lag. To the extent that you cash out stocks from time to time to fund your retirement, you want to make sure you are not beholden to a forever booming US stock market. The basic concept here is called asset and liability matching. Your liabilities are now overseas, so a greater portion of your assets should be as well.

6. Tradeoffs – Retiring abroad of course does not come without its tradeoffs. One should spend some time pondering the question: What do I give up? Social networks, proximity to family, and professional connections. Those are the biggest ones, in my opinion. Even with the marvels of modern communication, long distance is still a real thing. You are just not local anymore when you retire abroad.  

In the same vein, you may also lose the cultural familiarity, which perhaps you value more than you realize. You have left your tribe and you are now in a foreign land. Maybe the world is more interconnected and monocultural than it once was, but it is still a real thing. The stereotypical example I am thinking of, is an American in France. You can learn the language, respect & appreciate the culture, but you are not going to be French anytime soon. At some level, you have to be comfortable being the foreigner and accepting that how others perceive you is not necessarily how you wish to be perceived.

Another thing to be conscious of is the difference between living somewhere and being on vacation somewhere. Vacations are fun, living somewhere comes with daily routines, chores, and responsibilities. Maybe it was just being on vacation that you liked, not necessarily living there.

For example, some people may enjoy haggling/negotiating a little for the products they buy in an open-air market, or the taxis they hail. But if you had to negotiate every day for everything, would you still enjoy it? That is not so much a problem in Europe, but certainly comes into play in some other locales. Another example is food. Using Italy this time as an example: beauty is in the eye of the beholder, or the taste buds in this case, but what is there not to like about fresh local Italian food? However, if you have food sensitivities or just enjoy modifying your orders, it would be pretty hard to navigate Italian restaurants. As a waiter once angrily reminded me: the meal is complete. What he meant to say is that it could not be improved upon with my modifications.

In summary, I would say, if you dream of retiring abroad: go for it! Chances are, you can retire early to boot. However, I would recommend also having a plan B, and allowing for the possibility that it does not work out. If you can overlap a little by renting in your retirement destination for a few months before completely uprooting yourself, I would highly recommend that approach.

Investing while mindful of climate change or mindful of a changed climate. For years I have been working with clients who are concerned with climate change and have wished to exclude fossil fuels and emphasize clean energy and resource efficiency in their portfolios. But it is also good to be mindful of a changed climate when you are putting your investment dollars to work. It seems a safe bet to assume that the world is going to be hotter in many places, more prone to floods, to rising sea levels, to droughts, and to extreme weather events. Given that, where should one (not) invest? 

Through that lens, I occasionally generate some interesting investment ideas. Recently, I started looking at Carrier Global (CARR). During the recent extreme heat waves in Canada and the Pacific Northwest, it was widely reported that many homes lack air-conditioning. When the current housing stock was built, that just was not top of mind in those geographies, as summers had historically been fairly mild with hot days few and far between. Now, that perception has changed. Carrier Global, a manufacturer of HVAC systems, including residential and commercial air-conditioners, is well positioned for a changed climate. 

Portland, OR - Once in a thousand years? I fear not.
Portland, OR – Once in a thousand years? I fear not.

Moreover, and importantly, they score high marks on their environmental stewardship. Using an audited reporting system called CO2nservation meter, they have avoided 300 million metric tons of greenhouse gas emissions, equal to taking more than 60 million cars off the road for one year, by reducing the carbon footprint of their product lineup. Additionally, they have pledged net zero emissions of their own footprint by 2030 and have demonstrated progress towards that goal and the goal of improving water conservation. We will keep our “climate changed” radar on as the winners and losers of our changed environment increasingly become apparent and provide actionable investment/divestment opportunities.

Wishing you a fantastic summertime in a world that hopefully looks a little more normal than last year.

Kindly,

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Jan Schalkwijk, CFA JPS Global Investments

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