Today’s Trio: COVID, Inflation & Shortages
As we browse our bookshelf to bring you some reading of interest, we find the subject of COVID Variants between the bookends of ‘Inflation Concerns’ and ‘Shortages of Goods and Services’.
Just as our economic “reopening” is gaining steam, COVID variant cases are spiking with the highest concentrations in California, Arizona, and Texas. Concerns about back-to-school season and cooler weather abound.
Multiple COVID variants are finding their way into world populations with the Delta Variant spreading quickly throughout the United States. The CDC, or Center for Disease Control, tells us that vaccines are highly effective against severe illness, but the Delta variant causes more infections and spreads faster than earlier forms of the virus that causes COVID-19. Infections happen in a smaller proportion of people who are fully vaccinated, even with the Delta variant. Some breakthrough infections are expected but remain rare. However, preliminary evidence suggests that fully vaccinated people who do become infected with the Delta variant can spread the virus to others.
While the Delta variant is most prolific in the U.S., there are more than a dozen other variants being tracked worldwide.
We all see basic prices rising in food, energy, and housing. The big question is whether inflation is “transitory” or short-term due to specific reasons like demand from re-opening our economy, or whether inflation will prove to become imbedded within our economy at higher sustained levels, or perhaps morph into hyperinflation. Our initial thinking is of transitory or short-term - 12 to 24 months.
There are four factors driving inflation, and each have a different effect and length of impact.
First, the base-effect of simply measuring inflation will prove difficult, since an event like COVID is a new dynamic when looking at historical measures of inflation. Never has our world been smaller or more technologically driven. The inflation rate is not a static number, rather it is a measurement of the rate of change of prices so markets that depend on inflation data may face increased uncertainty. This base-effect will be transitory, although increased COVID spikes and business delays will have an impact.
Second, a shortage of goods increases demand that in turn increases prices. These increased prices for almost all consumer goods lead to inflated prices – inflation. We believe these supply chain disruptions will also be transitory.
Third, “core inflation” is likely to continue to increase as service and housing inflation trends higher. This is due to numerous issues such as supply chain disruptions, a shortage of workers equaling higher wages, and trillions of dollars of government stimulus. The direct stimulus checks and payroll protection programs are transitory, however new infrastructure spending bills totaling over $4.5 trillion are a real concern to the markets, especially the bond/credit markets. We note that the term “concern” does not reflect as much on the merits of the legislation but the simple monetary impact as it relates to our investments.
In theory, government spending increases aggregate demand which increases prices which creates inflation. The key is the definition of infrastructure, which we typically understand it to mean items such as roads and bridges. The money is allocated to a project and workers are hired, materials are purchased, and an economic impact multiplier takes effect for local stores and restaurants. Any resulting inflation is generally offset by economic activity and tax revenue is generated at a productive pace.
Another definition is human infrastructure: Some examples include funding for universal pre-school, free college tuition, federal family leave program, job training and expansion of federal health care benefits. Many of these are defined as transfer payments such as social security, a payment made for which no goods or services are being paid. As noted above, the term “concern” does not reflect so much on the merits of the legislation but the simple economic impact as it relates to our investments.
When compared to rebuilding a bridge that has a finite cost and a completion date, government programs tend to be open-ended endeavors with rising long-term costs. A strictly economic and thus market-based concern is two-fold. First, transfer payments, though worthy, create a limited level of economic activity. Second, a government funded worker will pay a percentage of income and payroll taxes back to the government as well as spur a certain level of economic activity and private sector activity, but it is not enough to overcome 100% of their compensation.
Thus, government debt, deficit spending, rising tax rates and more become concerns for owners of stocks and bonds. The psychology of the markets can be as important as the fundamentals. We have often said that the market can deal with good or bad news, it is the unknown that creates the most volatility. We believe that the second half of 2021 will exhibit more volatility and the unknowns surrounding inflation will be a factor.
Finally, several issues are coming together to lift wage inflation as the reopening of the economy progresses and companies pay more to attract workers. The shortage of willing labor is due to numerous factors including continued fears of the virus, limited childcare options and expanded unemployment benefits that may be keeping workers from returning to low-paying positions.
Shortages and Supply Chain Disruptions
The worldwide flow of goods and services is a very delicate balance due to just-in-time delivery of goods and minimal inventory management. There are numerous issues impacting the shortages we are experiencing. For one, many businesses worldwide closed due to COVID, so inventories of raw goods and materials fell. The semiconductor industry made very conservative predictions on demand during COVID and thus reduced manufacturing. This turned out to be an incorrect forecast as demand remained steady or even increased and most products these days require a semiconductor. There is also a worldwide shortage of shipping containers as well as the labor to unload them at ports. Many industries especially in the United States are experiencing a severe labor shortage due to continued fears of the virus, limited childcare options and expanded unemployment benefits that may be keeping workers from returning to low-paying positions. We continue to monitor these effects.
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