16 Dec 2021
FOR PROFESSIONAL AND/OR QUALIFIED INVESTORS ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. CAPITAL AT RISK. All financial investments involve taking risk which means investors may not get back the amount initially invested.
I have never seen so much inflationary pressure so early in an economic upswing. On the consumer price index measure, inflation hit 5.4% in September. Moreover, inflation expectations are now at a 10-year high.
Inflation expectations in the US have hit their highest level since the financial crisis
Source: Conference Board Survey of Household Expectations, Refinitiv Datastream
These are extraordinary times. The US – like other economies throughout the world – is facing acute labour shortages in many sectors. It is possible these may ease as the withdrawal of emergency support offered during the pandemic forces more people back into the job market.
The counter argument is that Covid has brought a day of reckoning following years of increasing inequality; it may be that many Americans are simply no longer prepared to work for such low rates of pay.
Simultaneously, supply-chain disruption around the world has left many US businesses perilously short of inventory. With so many companies struggling to secure sufficient supplies to cope with the return of demand, inflation has been the inevitable result. Again, the hope is that these pressures ease as supply chains normalise – but that may take some time.
Environmental regulations have reduced US crude oil output
Source: Refinitiv Datastream
There is another factor in the inflation spike: the effect of President Biden’s interventions. In particular, new environmental regulation has reduced US oil output, increasing energy prices. And here, too, the outlook is not entirely clear: the extent to which the President is able to manage the difficult arithmetic of Congress will determine how much further he can go with environmental taxes that will feed through into higher costs for the energy sector.
Inevitably, with inflation so far ahead of the US Federal Reserve’s long-term target, there is mounting pressure for a monetary policy response.
There is growing evidence of tensions within the Fed – and a shift towards tighter policy, including a more rapid move to tapering QE.
Happily, the Fed appears to be managing such speculation more successfully than in the past. There has been no repeat of the 2013 ‘taper tantrum’, when investors panicked at suggestions the Fed would begin reducing support for the economy in the wake of the financial crisis.
Expectations are that the US economy will significantly outgrow most other advanced economies in 2022. Goldman Sachs recently raised its forecast for US GDP growth in 2022 from 4% to 4.4%, so we could see cyclical stocks rebound again – especially if international travel lifts off properly.
Keep in mind, too, that most of the difficulties the US faces – including inflation – are also being felt globally. The difference is that the world’s largest economy has more breadth and greater depth with which to withstand the pressure than any other country. It also currently enjoys the advantage of being home to an exceptional cohort of disruptive growth companies with huge global brand power.
Some industries, after all, will find it much more straightforward to pass on higher costs to customers than others. The commodities sector tends to be able to outpace inflation; those selling consumer goods less so.
One potential route through so much confusion is to focus on another outcome of the Covid crisis: there is no doubt that the pandemic has accelerated the pace of technological progress in many industries. Bricks-and-mortar retail, for example, has moved from managed decline to an embrace of ecommerce.
Businesses able to leverage these new technologies are circumventing many of the pressures faced by their less advanced competitors.
Railroads that have continually invested in new technology look particularly appealing. Norfolk Southern is running longer trains (1.77 miles long!) more cheaply and more safely as a result of investing in tech, enabling them to raise prices while still undercutting road transit competitors, thereby protecting profit margins.
Elsewhere, robotic surgery systems produced by another holding, Intuitive Surgical, make it possible for doctors to perform less invasive operations. With little competition, pricing is protected – particularly given soaring demand from health authorities that need efficiency to bring treatment backlogs down following the pandemic.
Inflation in the US may be higher and more persistent than we would like, but the medium-term prospects for the US economy and market look good; the opportunities for the thoughtful stockpicker look better still.