Inflation and interest rates remain the name of the game, causing whipsaws in cyclical stocks relative to go-go growth this week. Longer lasting inflation means higher interest rates. This helps industrials, banks, commodities, and some consumer stocks which have pricing power. A reversion back to a life of sub 2.0% inflation would put a cap on long-term interest rates and push investors into long-duration stocks with higher relative P/E’s and better growth metrics. It is a classic growth vs. value game, where the latter has taken charge since the Fall after a decade of lagging.
Commodity prices have gone parabolic since the onset of emergency use approval for the Moderna and Pfizer vaccines last October. We’ve all heard the cost to build a new deck for our houses has quadrupled over the past year. Ditto for most commodities, however more supplies are coming. Factories are slowly reopening and employees are gradually coming back to work. Platinum, palladium, and soybeans are all down 10% from recent highs. Iron ore, lumber, corn, wheat and natural gas are 15% – 25% lower in just a few weeks. Interest rates have followed suit, though not declining nearly as much this month. This led to a mini-consolidation of gains in reopening and cyclical stocks. After a straight-line advance this is preferred, relative to inflating a bubble that eventually pops.
Yesterday showed a breakout of sorts from our consolidative phase for many industrials, led by very positive news coming out of Airbus. Anyone who has booked a flight lately noticed a massive surge in prices relative to last year and even pre-pandemic. Airports are jam packed. Planes are coming out of hibernation while airlines increase orders for new deliveries. Two new airlines started taking off as well over the past month. Airbus asked suppliers to ramp up production levels so they can deliver many more new A320’s over the coming years than were expected. Air travel is fully back on the recreational side. Speaking with business owners and sales heads is leading many to believe corporate travel is not dead by any stretch either. It will take time to get back to, or even approach, 2019 travel budgets, but it has already begun and is coming faster than expected. People want to interact face-to-face.
It has been clear for a while that people want to vacation, but corporate travel is where abundant profits are created. Hotels, restaurants, car rental agencies, home rentals and even credit-card operators depend on business spending to hit lofty expectations. Business conditions have changed as Zoom is here to stay, but many large deals, factory installations or commercial upgrades require a physical presence. The quicker this portion of the economy comes back, the better for every part of the travel flywheel. Airbus’ update is a great initial sign and brought decent gains for industrials on Thursday, especially those in the airline food chain. In total, General Electric#, Boeing# and Raytheon# were up 7.1% (new 3-year high), 3.9%, and 2.4%, respectively. This follows auto manufacturer news that plants are coming back online following a closure due to chip shortages. Appliance stores are finally seeing inventory levels rising again. China is pushing back on higher commodity prices and bad actors. Even available homes for sale turned back up a bit. The end result is that higher prices are bringing more supplies to the market. For now, the Federal Reserve’s analysis that inflation will be transitory is looking realistic if these trends hold.
That doesn’t mean inflation is over, not by any stretch. Commodities are just one input to the equation. GDP for the second quarter could be around 13%, the best since 1951. Massive monetary and fiscal stimulus show no signs of dissipating. Globally, vaccine injections are catching up to the U.S. Global growth will accelerate, playing a little catch up to America. Personal wages for April were exceptional and more gains are expected. Pent-up demand is real and consumer balance sheets are in great condition. Today’s excess saving rates are tomorrow’s spending cushion. Our Fed will take it very, very slowly to start down the tapering path. Combined, these add up to a relatively attractive environment for inflation to stick around.
The U.S. is a service economy today, not a manufacturing one. More services are reopening as the last few states lift restrictions. Anyone who is able to get a reservation for dinner is seeing a higher than usual tab. A round of golf in my area is double the price of 2019. Ubers and Lyfts are either unavailable or always in “surge” pricing tiers. You can’t find a rental car in any airport unless booked months in advance. Servicing any appliance at your home comes with upfront costs just to show up. Concerts, cruises, operas and sporting event ticket prices are astronomical. Inflation is certainly here today and going to stick around for the rest of 2021.
Just as travel demand rebounding leads to airlines ordering more planes, a reopening of our service economy will bring more competition, expanded operations and more neutral price levels. Higher prices in all facets delivers an increase in supplies. That doesn’t mean the market can’t get ahead of itself in the coming months and price in more inflation though.
After a news vacuum the past few weeks, it could get interesting in early June. Employment, CPI, PPI and another Fed meeting are on tap. Headline inflation could peak at a 5% rate for May while core PCE inflation is expected to surpass 3% for the first time since the early 1990’s. Following the largest jobs miss on record, who knows what happened in May. The powerful combination of expanded unemployment payments, concerns about Covid-19, family responsibilities with children learning remotely, and unskilled labor may create another lackluster employment update. Our Fed is leaning on its full employment mandate before pulling the punch bowl away, so these updates are critical for inflation bulls and which stocks win.
From here, the approach remains the same. Portfolios should be positioned for inflation with the knowledge that it could last longer than expected but is not likely to stay forever. Go-go growth stocks are hard to love in a rising interest rate environment but long-term disruptors that are taking share will eventually win out, especially if they can turn a profit. Cyclical areas are pricing in a lot of good news. Any inflation update could lead to transitioning portfolios in either direction.
For this long weekend, we send our appreciation to all service members who put their lives on the line for our country. Markets are closed on Monday in honor of Memorial Day.
I heard through the grapevine that Gladys Knight turns 77 today. “The Loco-Motion” singer, Kylie Minogue, is now 53. Marco Rubio celebrates his 50th today as well.
James Vogt, 610-260-2214