2021 was a perfect storm for consumer price inflation. An expanded money supply, less precautionary cash hoarding, stimulated and pent-up demand for consumer goods, and supply constraints have all combined to fuel a rapid rise in inflation: CPI is up 6.2%, YoY, Oct’21 shipping rates up 153% YoY, food prices up 31% YoY, energy costs up 74% YoY, house prices up 20% YoY, Dollar Tree raised its prices to $1.25 … even turkey prices were 25% higher for Thanksgiving this year!
Considering recent data (and headlines), many investors are baffled that equities remain at or near all-time highs and bond yields remain rangebound near rock bottom levels. In our view, it is not a surprise that markets are ignoring the panic. These conditions are consistent with the present economic environment, and more importantly, with prospects for the year ahead.
The global economy is growing above trend, with no risks of recession in any important region, and with profits rising across almost all sectors. However, the explosive growth rates of the immediate post-lockdown periods are subsiding to more sustainable levels. This slowdown means that inflation, although higher than it’s been since 1990, is likely to peak in the next few months. As a result, major central banks are almost certain to keep policy rates far lower than ever before in financial history, even if the first rate hikes do begin next summer, instead of the winter of 2022-23. The futures market is already pricing in 3 hikes by the Fed next year, which implies much of the current inflationary dynamic is priced into markets. The combination of strong growth and rock-bottom interest rates implies the returns offered by equities, credit and other risk assets are attractive. Thus, we feel it’s prudent to maintain an overweight stance to equities and credit in our portfolios.
And despite all the headlines calling for structurally higher inflation, we believe market inflation expectations have remained quite cool. Not only have bond yields stayed comfortably within their 1.25% to 1.75% range, despite last week’s “shock” CPI reading, but inflation break evens and surveys have risen only slightly, implying 6% inflation as a meaningless statistical quirk.
A major reason we discount this month’s inflation panic is simple. The surge in inflation over the 12 months to October 2021 was partly a rebound from the slump in inflation to 1.1% in the previous 12 months. Taking the 24 months together, US inflation, has been running at an annualized 3.7%. While 3.7% is above the Fed’s Target, it is moderate and remains within central bank comfort zones. And this comes after a decade of undershooting this target. Once we recall that the world just went through an unprecedented economic dislocation with extreme swings in consumer demand and supply capacity, no one should be surprised by these price movements. And rather than extrapolating 6% inflation into the long-term future, it’s much more reasonable to expect prices to stop moving wildly as effects of Covid distortions dissipate. Even if this takes longer than expected.
Therefore, we still believe after a transitory pickup in inflation in 2021, prices will ease in 2022, and structural deflationary trends will reassert themselves. This will allow central banks to remain accommodative.
Last month, we exited our position in Gold and increased our position to international equities as the global recovery broadens out.
Finally, know that all our Strategies will adapt to fundamental or rules-based, not emotional influences. We seek opportunities for solid risk adjusted returns and to preserve capital in asset market downturns.
1 Information as of 10/13/2021. Individual account allocations may differ slightly from model allocations.
Recent Portfolio Changes
We exited our position in Gold and added to our International Equity position. We believe international equities will benefit from attractive relative valuations and a broadening global growth environment.
John A. Forlines III
Chief Investment Officer
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