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In the Markets Now - Checking in on Inflation Thumbnail

In the Markets Now - Checking in on Inflation

By: Ross Mayfield, CFA
Investment strategy Analyst

We believe in the old saying: a picture is worth a thousand words. Here, we aim to recap recent market action and provide some perspective to investors.

A HOT CPI REPORT SPOOKED INVESTORS, BUT WHAT’S THE REAL STORY?

After taking a few weeks off, what else can we do but return to the topic on everyone’s mind: inflation. With a smoking CPI report now a few weeks behind us (featuring the highest jump in core inflation since 1981), let’s talk through some of the dynamics at play. The April report both beat expectations and was incredibly interesting, but was also maaaybe not that prescriptive due to some of the unique forces at play (mostly Covid-related).To dig into it, let’s use one of the main examples of price insanity—used auto prices—which were up 21% year over year and had an outsized effect on the headline number:

  • Base  effects. When  looking  at year-over-year  data, don’t  forget  about  the  denominator. In  this  case,  the denominator—last year’s used car prices—cratered as consumers tightened the belt (anticipating a recession) and big firms liquidated rental fleets (also anticipating recession). In hindsight, the big drop in used car  prices was a one-off effect of the temporary pandemic/lockdown (same as the one-off spike in, say, hand sanitizer prices).

  • Reopening  demand. Bolstered  by a  healthy,  stimulus-juiced consumer and better-than-feared results from car rental services, demand for used autos is returning at a breakneck pace. Rental car companies are desperately rebuilding their fleets as travel demand temporarily surges, creating short-term spikes in prices.

  • Supply  constraints. Nothing  embodies  the  pandemic-related supply-chain  issues  like  semiconductors,  and  nowhere  has  their shortage been  more  noted than  in  auto  manufacturing.  With demand   surging,   supply remains constrained by shuttered production (Covid + worker shortage) and a lack of needed parts.

And  this  combination  of  issues  is playing  out all across  the  economy. Reopening-linked items (e.g. airfare, hotels) are seeing massive demand, and many goods (e.g. microprocessors, lumber) are dealing  with supply issues. Still, these  are  mainly  Covid-related  issues;  there  is  little  to  suggest  that  these  types  of pressures will be permanent and result in the type of year-over-year-over-year inflation that is genuine cause for concern.

In fact, supply for many goods (cars, iPhones) are being beefed up as we speak. Some improvements will take longer than others (it takes longer to build a new copper mine than a microprocessor), but producers are ramping up to meet demand and  technological  improvements  across  industry  will  help  with  speed.  As  Goldman  Sachs  notes,  the  most  prominent example of the current supply chain disruption—the shortage of microchips for autos—is set to fade later in Q2. Past that, consumers are also increasingly likely to start shifting dollars to services over goods—travel, NBA games, Marvel movies.

But Covid weirdness aside, there are also reasons to think inflation could be a little more persistent this time. There’s a lot of money in the economy, and the Fed has a challenging dismount ahead after years of easy policy. Further, signs of real and persistent wage growth (esp. in lower income segments) paired with skyrocketing home prices both could easily juice the inflation data. And unfortunately, neither of these issues are as easily solvable as “turn the factory back on.”

Still, I ultimately land on the conclusion that while inflation may run hotter than we got used to in the 2010s (and maybe for longer than some are comfortable with), it won’t veer into problematic territory (much less hyper-inflation). This was a unique crisis, with a unique recovery, spurred by historic policymaking. But as we return to normalcy, the inflation data should begin to, as well. Reach out to us with any questions or for further commentary on inflation.

Disclosures
This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here  reflect  our  judgment  at  this  date  and  are  subject  to  change.  The  information  has  been  obtained  from  sources  we consider to be reliable, but we cannot guarantee the accuracy.

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