— There is mounting evidence that the current bump in inflation is just the beginning of a longer-term trend toward higher prices.
— Higher labor costs, insourcing to secure our supply chain and exogenous pressures on raw materials will be the main culprits.
— The media will have a field day since this supposed bad news and the rhetoric that comes with it will be front and center as they work to increase viewership and readership.
— Will this be the straw that breaks the market’s back?
The Case for Higher Trend line Inflation
Much of the thought process I present in this section comes from real world observation, like all those help wanted signs festooning businesses across the country. Why is it restaurants can’t hire wait staff and cooks or retailers staff to manage their brick and mortar assets? Please don’t respond ‘enhanced unemployment’ benefits. They have been gone in Kansas City, Missouri since June. The possible correct answer, which may have been given to me by the manager of my country club’s dining areas, is that they have found other more desirable jobs away from food service. These are jobs with regular hours, benefits and better pay. Forget about the $7.35 minimum wage. Our manager can’t hire people at $18.00 per hour. Covid may have given many workers a chance rethink what they were doing and the opportunity to look for and find better.
It also appears that some employers may have figured out that for many jobs that have been going begging there is no need to have a baccalaureate degree to meet the abilities required to do those jobs. IBM has established an apprentice program to do just that. I am attaching a video from a recent edition of the PBS News Hour that details this program and three qualified new hires who left low-pay, low-end jobs to join the company. Likewise three low-end, low-pay jobs have opened up that nobody wants, not even at $20 an hour. This doesn’t feel transient to me.
Photo by Remy Gieling
Because of increasing inflation in manufacturing costs abroad, rising transportation costs and supply chain issues, companies are bringing production back to the US. Look no further than the US automotive industry as the poster child for this movement. Even with automation it is hard to imagine how this does not get built into higher prices as we move forward. This should also put upward pressure on labor costs.
Exogenous-the stuff we can’t control outside the US
I’ve mentioned this before but I think it is worth repeating: the US is not the only place on the planet that has demand for raw materials and consumer goods. There are at least two to three times our population in the middle classes of China and India and they all want to live like us. This equates to huge demand for raw materials that 20 years ago didn’t exist. We created this demand on the backs of cheap foreign labor. Now it is time for payback as they and their new wealth compete for resources.
One last item before we leave this section is the cost of going green. This is going to be expensive and there may be a hidden costs to pay the in the transition from conventional, hydrocarbon energy sources. It is possible that there will be a significant mismatch of supply and demand for oil as this transition takes place. Why? These companies aren’t stupid and will be doing everything that is in their power to survive. Most likely they will not invest in finding new reserves or increasing production from existing reserves instead using the new cash flow from today’s higher prices to pay down debt and invest in greener energy producing alternatives. Production for oil and gas wells starts to decline naturally as soon as their production begins. If production falls faster than demand we could be setting up for a huge spike in oil and gas prices.
The Media Will Have A Field Day
Half the battle in this game is having some idea of what to expect. So be prepared for the media to be screaming from the rafters that this greater-than-expected inflation is a huge problem. It won’t be if you own productive assets according to Scott Grannis, a bona fide inflation bear:
“Unfortunately, there is little that investors can do. Cash remains trash, as its purchasing power is being seriously eroded by inflation. Ditto for most fixed-income securities. Better to own productive assets that can ride the tide of higher prices (equities, commodities, commercial property). Prudent levels of debt (at long-term fixed rates especially) should benefit from higher prices and a general loss of purchasing power.”
Scott Grannis was the chief economist at Western Asset management (1989-2007)
I’m not as dour in my inflation feelings as Mr. Grannis, but support ownership of productive assets in an inflationary and accelerating inflation environment with one caveat: higher multiple stocks will have trouble with inflation induced higher interest rates.
An opposing point of view from the media
“Action in the market is screaming: We don’t have an inflation problem.” “The rich have the most lose from inflation” “Inflation erodes the purchasing power of their money and savings.” “There are tons of business owners and execs who want the Fed to crush the labor market so they won’t have to give anybody a raise. They want Powell to tighten because it would help their bottom lines.” –Comrade Jim Cramer of Cramerica fame.
Yes, he really said this. Here is a link to the video.
Bottom line. No, this will not be the straw that breaks the market’s back. Don’t let the media scare you out of your stocks.
What’s your opinion?