Have you noticed empty shelves at your local grocery store? If you did, you are not alone. According to Rasmussen in October, 62% of Americans have noticed shortages of basic goods. Some of those goods are sitting in masses of cargo ships backed up around our ports. The pundits are talking of inflation on the news, almost always with the word “transitory” and a reassuring tone that it would eventually go away. The message is clear; don’t believe your lying eyes. In our KnowRisk from first quarter of this year we wrote, “With demand up and supply uncertain, the potential for price increases, otherwise known as inflation, is high.” That potential has materialized, so it’s time to explore what this means and what might happen next.

To cover the basics, inflation is simply an increase in the general price level of the goods and services that Americans transact every year. Inflation is also often defined as too many dollars chasing too few goods. Almost six trillion in additional government spending created those extra dollars and the fewer products were created thanks to factory shutdowns. Since then, inflation has trended hotter than the regulators expected. As recently as June, the Federal Open Market Committee projected that 2021 would end with inflation mostly between 2.9-3.6% (graph on next page) and those inflationary pressures would still be transitory. The target rate for inflation is 2% and the economy has run below that for more than a decade. Thus, the Federal Reserve has stated they want the economy to “run hot” for a little while.

By August of 2021 however, Personal Consumption Expenditures (PCE) inflation reached 4.3%. The FOMC still predicts inflation to be transitory, but now their midpoint prediction is for PCE to end the year 5.8-5.9%. Along with their updated PCE number, Powell has also indicated that tapering of asset purchases (including mortgages) will begin at the November meeting. Hopefully Powell has telegraphed this change clearly enough, but we might see upcoming market volatility.

How does inflation affect the stock market? Warren Buffet recently compared inflation to a “gigantic corporate tapeworm [that] preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism.” Inflation can increase the cost of production and the resulting products, which hurts businesses slow to adapt and consumers on fixed incomes. Colorful metaphors aside, we have to understand the underlying fundamentals if we want the best clues as to the coming effects. If this inflation is just the result of temporary cash infusions and COVID shut downs, then price levels should stabilize as these temporary disruptions wind down. According to the US Government, Americans have been incredibly busy and spent down approximately $3 out of the $4 trillion in additional savings we set aside during the lockdowns (chart below). However, other factors might be longer lasting.

A significant portion of the inflation we are feeling is due to increased costs from labor shortages and higher energy prices. Businesses have expanded hiring to give America the highest number of job openings in history (10.5 million). As we recover from the Delta variant, some of those jobs will be filled. In energy, oil stockpiles have declined to averages last seen in 2014, and global inventories continue to draw. Goldman is projecting oil to hit $90 by year end, and the number of rigs drilling in the US is still below average for the previous decade.

The key question going forward is “Can we maintain or exceed this level of production in the face of rising prices, including the price of oil?” With more people returning to work, businesses adapting to market conditions, and price levels stable, signs are optimistic. No economy is without risk. A further dramatic increase in energy cost, or new regulations increasing the cost of hiring or manufacturing would be a negative shock to the economy. In the 1970’s the US experienced a combination of stagnation and inflation, called stagflation. Central banks have changed dramatically since then, adding far more tools to their repertoire. Equitas examined both scenarios (high growth/high inflation, low growth/high inflation) on a quarter-by-quarter basis. The chart below displays the results. A booming economy acts like a rising tide lifting all boats. When the economy slows, there’s almost nowhere to hide.

New technology pundits like Cathie Wood tell a different story about inflation, believing that new technological innovations will be deflationary. Industrial productivity can be enhanced eliminating the need to raise product prices. Wage demands are the largest component of inflation and automation means fewer workers are needed taking the pressure off rising wage demands.

Some combination of these inflationary and deflationary economic forces will become evident next year. Few of today’s investors were active in the super inflationary days of the 1970s. No one has seen the government spending we see today. No one knows the effect of all the technological changes that are coming at us in exponential speed. We find it best to be prepared for any combination.

In 2002, Equitas Capital Advisors, LLC was established as a unique company that blends the resources of a large global corporation with the flexibility of a small boutique firm. The registered service mark of Equitas Capital Advisors is Engineering Financial Solutions® and the purpose of Equitas is to design, build, and deliver investment solutions to meet the goals and objectives of our investors. Equitas Capital Advisors, LLC located in New Orleans, has over 200 years of combined investment management consulting experience providing professional investment management services to investors such as foundations, endowments, insurance companies, oil companies, universities, corporate retirement plans, and high net worth family offices.

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