Stocks continued to edge lower as concerns about inflation, supply chain issues, and Washington politics continued to weigh on investors. This morning starts earnings season with three big names reporting, JP Morgan Chase#, Blackrock#, and Delta Airlines. JP Morgan Chase should provide the best view of the economy overall, mainly through comments regarding loan demand. Delta Airlines could offer some insights on pending Christmas travel, plus the impact of Covid-19 related restrictions to date.
Perhaps the best piece of news this morning is the announcement that the port of Los Angeles is expected to go to 24 hour per day operations. There have been some recent signs that the pace of offloading ships has accelerated, but containers continue to pile up. Solving a logjam requires the efforts of not only longshoremen, but truck drivers, port operators, politicians, and others. President Biden has called related leaders to the White House and clearly wants a commitment that efforts will increase to alleviate the supply chain problems stemming from all ports. The problem won’t be solved overnight, but it is an important step in the right direction.
All the shortages have led to higher prices. Whether it be oil, cotton, or steel, commodity prices are shooting up. While inflation watchers tend to look past spikes in commodities, clearly some of those incurred costs get passed on by producers of finished goods. That will be a common theme of earnings reports we hear over the next few weeks. The key for long-term investors is how much of the current inflation is structural. Shortages of coal and oil can be alleviated by price. Higher prices evoke more supply and less demand. But what about labor? Yes, higher wages will entice some to join or return to the workforce, but will that be enough to keep wage inflation within normal bounds? So far, the market says yes, especially if productivity can grow at least 2% per year. The reality is that we won’t know for sure for at least another year. With that said, if the peak of supply chain disruptions is upon us now, the picture should improve as we enter 2022. That doesn’t mean total balance is restored any time soon. It may not be until 2023 or beyond before all the imbalances are corrected, but markets look at trends. They look at the second derivative, the rate of change.
Today we live in a world where demand exceeds supply. That is pretty evident when we look at prices and supply bottlenecks. The last thing the economy needs is massive doses of additional stimulus. To that end, the Fed’s November FOMC meeting takes on added importance. If one only looks at current data readings, the conclusion would be that the economy is slowing faster than expected. The Delta variant is still causing havoc although fading rapidly. Too many remain unvaccinated. Markets are not behaving particularly well. It has all the excuses to defer the beginning of tapering until December.
That would be a big mistake. The last thing needed today is any further demand stimulus. On the fiscal side, some of the programs designed to help avert a serious economic collapse or recession have expired. No more PPP. No more enhanced unemployment benefits. They aren’t needed anymore. But now progressives in Congress want to authorize another $5+ trillion. Thankfully, that now appears unlikely to happen. The progressive caucus may be stubborn for a few more weeks or even months, but there is less appetite today for spending on that order. They have tried for months and simply don’t have the votes. Most likely, something will emerge, but it is more likely to be half of the original ask. Most of that spending won’t begin to kick in until fiscal 2023, assuming a bill can be signed into law this calendar year. Authorizing 2 years of Pre-Kindergarten is one thing. Implementing it is another. A large percentage of Pre-K today is done in religious affiliated institutions. Just as parochial schools can’t be funded with government money, the same is likely to hold true for Pre-K. Building a replacement infrastructure will be both time consuming and costly. The same thought applies to roads and bridges. Providing the money is the easy part. Getting permits and authorizations can take years.
If we pull this all together, we see a picture of near-term chaos and an ending of above average growth with only moderate inflation. The roadmap to get from here to there is a bit fuzzy. It is likely to take many months or even years. Think back to the spring of 2020 when the nation was in lockdown. We all knew it wouldn’t last forever. We knew some businesses weren’t going to survive. The future of airlines and hotels were in doubt. But any rational person could figure out that the lockdowns wouldn’t last forever, that the pandemic would end someday, and that when the dust settled, there would be planes flying and hotels to stay in. But we couldn’t see tomorrow, we could only see the storm overhead.
A bit of inflation and supply chain snarls are hardly the same thing as a national lockdown. The problem is less severe. It isn’t life threatening to anyone, but if unsolved, much higher inflation could play havoc with financial markets. With that said, look at oil and gas, just for an example. The current problem was created by a lack of coal in China, the lack of wind in the North Sea, and low inventories to start. A larger than expected surge in demand has caused a spike in prices. A harsh winter will be expensive, but there isn’t a shortage of oil and gas. We all know where there are plenty of oil and gas reserves. It may take a few months to achieve balance once again, but we don’t live in a world running out of fossil fuels. Long term in fact, we live in a world destined to move away from fossil fuels. But until there are a lot more electric vehicles on the road, gasoline will be part of our lives. There will be no solar panels or pinwheels on the roofs of our vehicles!
Markets care about long-term trends, not near-term spikes. I have said many times that markets hate transitions. Today that thought is accentuated by the faster than expected inflation, and the larger than expected supply chain problems. You will hear all about both as companies report Q3 earnings. In many cases, near-term expectations for earnings will have to be adjusted downward. That could cause a volatile market during earnings season, but these are not long-term issues. Ports will function normally again. Inflation may end up as much as a percent higher than anticipated, but we can all live with that.
None of this is to say that stocks are cheap. They are not. If rates do nudge higher, P/E ratios will nudge lower. Indeed, they already have. The process is probably not complete. However, earnings growth is going to continue and that will mitigate the downside damage. We need to build more homes and we need to replenish our auto inventories. Those two factors alone will drive GDP higher. Indeed, restocking to normal inventory levels will be a theme of 2022 and a driver of earnings. As that becomes a focus, markets will recover.
Today, Sasha Baron Cohen is 50 and Jerry Rice is 59. Paul Simon is 80. It is also the birthday of my lovely wife, Susan. If I disclosed her age, I wouldn’t be married any longer.
James M. Meyer, CFA 610-260-2220