Finally, we get a relatively tame week with respect to the major averages. The S&P 500 traded within a 25-point band, but is still above last week’s record close. There has been more action in bond land as our 10-year Treasury attempts to put a bottom in at the 1.10% level. Yesterday’s spike in the PPI report for July caused a little stir. That yield is up 7bps this week to 1.37%. Even though it was quiet, we have a few items to discuss, namely CPI and PPI reports, a bipartisan infrastructure bill and my field trip to the local mall.
Let’s start with the most important item of the week as it pertains to inflation. We’ve noted over the past year, most stocks are tied at the hip to the yield curve. Tell me where the 10-Year yield is going and I’ll tell you where the market goes. Predicting interest rates has been a fool’s game for decades with economists consistently calling for higher rates since the 90’s when I started in this business. Betting against them has been right more times than not. While nearly everyone called for higher rates five months ago, the 10-year interest rate is still ~25% lower than March.
This week offers even less clarity than before with respect to inflation, and potentially our path on rates. Consumer inflation (CPI) for July confirmed what many have been expecting, peaking inflation growth rates. Data came in slightly below estimates with prices slowing their ascent substantially. A picture is worth 1000 words:
The drop off was substantial, albeit increases are still well above normal economic times. A continual 0.5% monthly increase like July would lead to 6% inflation rates; which is way too high. Used car prices, which have been rising by 7%+ for three straight months were basically flat in July. Other reopening themes showed similar drop-offs. Higher prices dampened demand, as usual. Depending on what your definition of “transitory” is, this looks like a report the Fed would prefer. Shelter increases are a headline risk as inflation there is stubbornly expanding. Rising home prices, a return back to city living and tight supplies are giving some landlords pricing power again.
On the other hand, producer prices (PPI) for July came in well above forecasts and were basically double that of CPI. If producers’ costs are rising twice as much as they are charging the end consumer, profit margins could be in trouble. Much of that increase came from services, namely passenger fares and hotel room rates. Further, new auto prices surged due to a continued shortage of semi chips. Eventually, these should subside as well but interest rates rose after the report. Anything that pulls forward a tapering phase is going to make investors anxious. As discussed in my prior notes, this may not be based on anything other than fear. Much like the Fed, we remain data dependent.
On to the infrastructure bill. The Senate passed a $1T, 8-year investment plan to help improve many facets of America’s declining infrastructure. Much works needs to be done before it passes in the House though. Following their summer recess, negotiations begin and we expect some sort of an agreement by mid-Fall, hopefully. Construction labor is already a bottleneck and most projects will need a planning phase. Even though the plan is to spend ~$110B annually over the 8-year period, most companies outside of engineers won’t see any activity until 2023. This is a long-term project, although stocks are pricing in good news today.
This bill isnt all roads and bridges either. $39B goes to public transit and another $66B to freight rail. Electric vehicles, mainly charging stations, get $15B. Airports another $25B. Water Infrastructure, a necessary field, $55B. Power Infrastructure (a lot of green energy projects) and oil & gas cleanups get nearly $100B. Lastly, highspeed broadband is allocated $65B.
My two main concerns are timing and labor supply. We already have a shortage of labor, especially in housing and construction. Construction employment levels are at their highest point ever at 7.6 million. We will need at least another 500k from this bill alone. Who knows where they will come from. As for timing, large projects like these need designs, engineers, bids, plans, state and local approvals…etc. 2023 may be an optimistic time frame before shovels hit the ground. Beneficiaries have seen stocks skyrocket prior to the bill with some more upward action this week. It will be difficult to achieve upside targets in the immediate future if there are delays. This is the Government after all, delays should be expected.
Lastly, my monthly trip to the local mall in King of Prussia, one of the larger in the country. Last Fall, once we were allowed back, there was a steady flow of traffic which continued well into Spring. Pent-up demand and flush pocketbooks were prevalent. Walking around this week and one would think it is Christmas season all over. Obviously, back-to-school shopping season is upon us, but I don’t recall seeing anywhere near this many people in 2019. Lululemon#, Apple#, Gucci and Louis Vuitton stores were packed. There’s a reason why Dick’s Sporting Goods, Ulta Beauty and Simon Property Group# have rallied back to new highs lately. The US Consumer is in amazing shape and we love to spend.
On the other hand, supply issues are still here. Many shelves were empty, especially in electronics and high demand items. Recent reports show semi supply chains are up to 20 weeks behind on deliveries. Help wanted signs are everywhere. Restaurants have limited menus. Today’s purchases are fueled by past stimulus checks and extended unemployment benefits. What will consumer balance sheets look like next summer? Will shelves get stocked in time for Christmas? Supply chains are not getting repaired quickly enough. It will happen, but not according to everyone’s preferred transitory timeline. Delta outbreaks are forcing China to close major ports again. Inflation is going to stick around through the end of 2021, albeit on a declining scale. If there are “must-have” gifts for anyone this year, get your orders in early!
Sebastian Stan, AKA Bucky Barnes in Captain America, is 39 today. Sarah Huckabee Sanders turns 39 as well. Treasury Secretary Janet Yellen is now 75.
James Vogt, 610-260-2214