The end of summer hit markets with a Covid wallop known as the Delta Variant. Stocks were broadly unchanged since June, having erased all gains in a September swoon. Many of the new viral cases occurred in those populations which had not received the “Jab”, especially students returning to college and young people. Those crazy college kids gotta party, especially after being socially restricted for a year and a half. I can still remember what it was like to be young and invincible.
Global labor scarcity, production shortages, and supply chain disruptions have all managed to restrain the Raging Bull. Auto manufacturers continue to shutter factories due to a lack of parts, especially microchips. This extended through the global economy as hundreds of container ships are parked offshore waiting for a place to unload. Christmas may be late this year.
Economic progress may have slowed but we remain optimistic. The trend lines of the pandemic are improving as most of the population has either had Covid or been vaccinated. Hopefully we may be approaching some state of herd immunity with the worst of the pandemic behind us. Merck has just released a drug which cuts death by Covid in half, and other antivirals are poised for release as well.
After this summer’s speed bump, the recovery will only have (probably) been pushed further into the future as the economy comes slowly back online. This should allow for improved market performance although over a longer timeline. However, current market gyrations are signaling increased uncertainty.
The Danger of an Inflating Economy
Months ago market pundits were calling the recent uptick in inflation a “transitory” event, which would subside once the economy returned to normalcy (however you wish to define that). Therefore, the Federal Reserve could safely maintain ultra-low interest rates while continuing to engage in “quantitative easing” (aka money printing). Concerns are now increasing that this inflation is not transitory but a result of unprecedented global money creation to combat the pandemic economic impact, in the face of stronger demand pressures amidst supply restrictions.
More money with limited places for it to go will inflate the balloon while deflating the currency, translating into higher prices. This concern is a contributor to Washington gridlock, where already approved Covid relief funds remain unspent, and the administration wants to add (print) trillions more. Interest rates are trying to rise as a result of the inflationary pressures.
Inflation is a cruel tax, especially on the poor and middle class. If consumers are forced to spend cheaper dollars to buy more expensive goods, there will be a lowering of the common standard of living. As for investors, business profits will be squeezed as the cost of production rises on fewer final units of sale. In an economy that is 70% services driven, a rise in labor costs will be a sobering event.
But enough of the microeconomics lesson. The macro effect is that growth is reduced, and markets struggle as business profits are squeezed. This is dangerous for investors, though they have so far benefited from asset inflation in equities and real estate. In case you haven’t noticed home prices have been on fire.
The stagflation of the late 70’s was a period of eroding wages, minimal growth and perhaps even more importantly, an increasingly restless citizenry. Some of us will remember the president at that time encouraging us all to turn down the heat and wear sweaters.
Investment strategy must reflect these risks. The long-term health of your financial plans requires earning a rate of return above inflation. For the first time in a very long time this is becoming a matter of elevated concern.
The truth remains that we believe equities remain the best option in an inflationary economy, especially for those sectors with the ability to raise prices. Bond investors, already earning little, will not fare as well.
Rocky Top Market
The beginning of October extended September’s negativity, and it is clear short-term volatility has increased. Conflicting forces are in a competition for traction, whether up or down. Large cap growth stocks and technology have been at prices which are significantly overvalued based on historical records. This cannot continue, and a little correction may be a good thing in achieving a more stable investing environment. Not all of the market is overvalued. Boring value stocks have been lagging the leaders for a very long time and may shine at times like this. Indeed, the best performing sector YTD is the traditional energy sector.
Any pullback will present opportunities to invest at better prices. We believe this would be a great time for investors as a rebound from the second leg of the pandemic occurs while corporate profits exceed forecasts. The global supply chain disruptions will eventually clear, aiding prospects for a re-ignition of growth. Families will go on vacation.
We will seek to rebalance to targets, take profits, and manage risks via a disciplined asset allocation approach utilizing asset class return expectations. Inflationary forces have emerged as a factor of increasing concern in weighing our decisions.
The boat may be rocking in a choppy sea, so hold onto your seat – clearer skies are ahead!