Thoughts On Inflation & Supply Chains
Posted on February 2, 2022
To see the American economy as boisterous as it is today should elicit gladness from wealth managers. After all, this is the first time the United States has emerged from a recession with stock prices near all-time highs, home prices escalating at rapid rates, households’ net worth at record levels, and Americans holding more than $2 trillion in excess savings in their bank accounts thanks to stimulus checks.
For those of you planning trips abroad and frequenting your favorite restaurants again, there has been a sense of relief and a pent-up enthusiasm to spend. But for other facets of the economy, there has been a peculiar stagnation unlike any with which we’ve dealt. Several million workers haven’t returned to their jobs in key industries like trucking, shipping, construction, farming, and manufacturing. Record numbers of container ships dock outside our ports waiting to be unloaded. Restaurants close early due to a lack of cooks. Store shelves aren’t as fully stocked as you remember. You’re paying 50% more to fill the gas tank or remodel a kitchen.
Indeed, our economy and stock market were tested in new ways in the second half of 2021. Economic conditions were generally buoyant and pointed to continued higher-than-average economic growth into 2022 on the back of strong demand across most industries. Now that most of the economy is open for business again, the savings that Americans socked away throughout 2020 and early 2021 was spent aggressively, and the swell in demand for consumer goods, property and other assets was unlike any we’ve seen in about 15 years. Demand for automobiles, new and used homes, furniture, clothing, cosmetics and restaurant food, for example, surged 15%-25% in the middle of last year, and even exceeded levels that would have been predicted had COVID-19 not occurred. Inventories of homes for sale fell to 1-2 months’ supply in major cities last summer, and sellers enjoyed receiving full-price offers within hours of listing.
As a counterforce, many industries were caught flat-footed by the surge in demand and have struggled to supply enough goods due to the logistical problems that arose from a lack of shipping capacity worldwide. It’s a classic supply and demand imbalance that should prove to be transitory, though economists and business leaders now admit that conditions will prevail longer than expected due to the ongoing dearth of workers. We forget that many of the goods we want to consume originate in countries where most workers still aren’t vaccinated. Certain businesses and industries, particularly professional services and high tech, have operated as normal since before COVID-19 shutdowns. They provide the best clues that the U.S. economy sits on a strong foundation for future growth once everybody is back to work.
We’re guided, too, by historical factors that keep us optimistic.
The solution to higher prices, in economics at least, often is higher prices. High prices for finished goods, raw materials and commodities tend to decrease demand and cause prices eventually to settle back. Indeed, we already experienced a 70% decline in lumber prices from their peak in May through September, over which time we also noted an increase in inventory of homes for sale and a slowdown in new construction and mortgage applications. The cost to rent a shipping container or buy a ton of iron ore likewise has fallen 40%-50% from recent peaks.
Prices and demand for goods seem to be reverting back to pre-COVID-19 levels. While headlines tout the extraordinary year-over-year price increases experienced for metals, materials, food, and energy in 2021, lost among the commentary was the fact that prices were rebounding off extraordinary lows of mid-2020, but yet are not much higher than we experienced in 2019. Should the supply and demand for goods even out again, we would expect prices for most goods to settle back onto the trendline that existed before COVID-19.
This time, and all times, is different. It’s a bold statement to make, but no two economic landscapes throughout American history have been identical. Every economic peak and trough was fed by different employment conditions, policy responses from Washington, and catalysts from the banking sector. Those looking for parallels between the stagflationary 1970s and today are looking past obvious changes in the economy that took place the past four decades. For one, there has been a massive transformation from a high-cost industrial economy (steel, aluminum, autos, refining, chemicals), to a low fixed-cost service economy (health care, retailing, and professional services). Since the 1970s, giant pools of cheap labor were unleashed after the breakup of the Soviet Bloc and the opening of economies in India and China. Labor unions don’t hold as much power to lock in inflationary pay and benefits packages as they once did. And the arrival of online purchasing has greatly diminished the ability of firms to charge more than competitors. All these forces are still working behind the scenes to keep inflation in check.
Timothy P. Vick
Director of Research,
Senior Portfolio Manager
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