Do You Believe in Inflation?
Key takeaways:
Inflation is still here, specifically in housing and hourly wage growth.
Expect continued supply chain issues.
Covid (↓) = Hiring (↑) + Service sector activity (↑) = Acceleration in income → increased consumption capacity
Some thoughts on the current environment:
Week over week, the number of Covid infections from the Delta variant continues to drop, implying that there is a reasonable basis for supply chain and labor to restart the path to normalization. Current estimates anticipate that the global supply chain will normalize after March 2022. Yet, there are multiple problems that exist, including a backlog of ships offshore as well as port, trucking and warehouse capacity. Global supply chain bottlenecks are feeding off of one another, with shortages of components and surging prices of critical raw materials squeezing manufacturers around the world. Even with all the headaches and supply demand imbalances, strong consumer demand is still here. For example, this last Friday, Apple released its new Apple Watch and the estimated delivery date was 2 months out. Clearly, consumer demand remains solid and the delivery of products remains iffy, so it may be best to start holiday shopping early this year to make sure gifts arrive on time.
Our investment process:
Fundamentally, our investment portfolios are built on BlackRock’s long-term asset allocation models coupled with our risk management framework. Our risk management process is built on growth, inflation, and policy decisions. Tracking these variables allows us to position assets with the highest risk-adjusted returns. Specifically, we are tracking the rate of change between GDP and inflation. Let’s dive into some of the data and take a deeper look at growth, inflation, and policy.
Looking at growth – As mentioned above, with Delta cases coming down in both the US and globally, we look to see prospects of activities that underline the increase in growth acceleration expected in the 4th quarter. These trends imply that financial numbers will soon begin to normalize as the post-Covid bump will be in the rear-view mirror. Also, as a projected 2.8+ million individuals start to re-enter the labor force, the economy from our model is forecast to have a mild growth rate in the last quarter of this year.
Looking at inflation – A sticky high inflation number for the US seems to endure into and through the 4th quarter. Housing inflation continues to increase as the largest percentage of core CPI. The second part of inflation is wage growth, and wages are clearly on the rise. The two industries with the largest year-over-year growth are hospitality at 10.8% and retail wages at 6.2%. As rents increase and hourly wages increase, our position that inflation is not transitory is reinforced.
inflation
Looking at Policy – From a policy standpoint, the last two years have shown us that the fastest growth in money printing globally has also produced the fastest pace of asset price inflation. However the Fed still believes that the inflationary environment is temporary: “The current inflation spike is really a consequence of supply constraints meeting very strong demand. And that is all associated with the reopening of the economy, which is a process that will have a beginning, middle and an end,” Mr. Powell said during a moderated discussion hosted by the European Central Bank (WSJ). Both Europe and the US will have to deal with increasing inflationary pressure in core inflation metrics. Specifically, the US will be adding an increased debt ceiling and a large infrastructure bill that will put the Fed in a difficult situation. They’ll have to slow down printing as the gap between year-over-year key economic metrics starts to shrink. The Feds current timeline is to conclude asset backed purchases by mid-2022.
What our model shows for the next shift:
With growth no longer tapering in the 4th quarter and inflation stubbornly staying high, our model continues to remain in the same risk exposure band as we have been for this year. Based off of our quadrant map, we are close to being squarely in the middle heading into quadrant 2 (i.e. increasing growth and inflation). Since we increased our tolerance bands in early summer, there was very little rebalancing to mention in the last quarter. Our model’s strongest probability weighting is to inflation so we have continued to hold inflationary type investments, like technology and energy, despite being the exact opposite position of the Fed. To balance this risk, we have substituted small companies with utilities as a low volatility exposure. Utilities will cap our upside but may provide better protection on the downside if we are incorrect. If you have questions about your specific investments, please reach out to us directly, we will also be reaching out in the month of November to start year end planning.
