Stocks rose sharply last week after a brief hiccup last Monday as investors worried about a default by a major Chinese real estate company. When traders accepted the belief that any default at Evergrande could be isolated and not spread across markets, it was back to the races for investors. The Fed at its FOMC meeting Wednesday did nothing to dissuade the bulls, setting a timeline to begin tapering for later this year.
Economically, all seems well. We will begin to see September data later this week, culminating in the monthly employment report next Friday. Numbers will continue to be impacted by the Covid-19 Delta variant, but could benefit from the end of extended unemployment benefits in early September.
One holdback has been ongoing supply chain disruptions. The backlog at key U.S. ports in Long Beach and Los Angeles continues to grow. Think of rush hour traffic. Roads can only hold so many cars at one time. When too many try to enter a highway at the same moment, traffic stops. It eventually unclogs when more people exit the roadway than enter. In the case of rush hour, the clog can last a couple of hours. Given the scope of the backlog at the California ports, it is likely to take months to clear. With so many goods purchased by Americans manufactured overseas, the resulting congestion can impact any kind of goods. Thus, at any moment today, one witnesses shortages of all sorts of items, enough to keep all of us scratching our heads. Our reaction is to stock more of what we think we will need. Last year’s toilet paper shortage is a perfect example. Americans hoarded more. Once their closets were stuffed, they stopped buying, store shelves could be replenished, and the crisis ended. We talk today about lack of inventory. Both companies and consumers, not knowing when the next shortage will appear, are responding by building their own inventories and trying to buy farther in advance. While that is happening, the situation worsens. But it will end, just as rush hour always ends.
In the meantime, lead times lengthen and prices rise. The scope of the supply chain problem is aggravated by a shortage of workers. Unloading ships, loading trucks, and driving 11 hours a day cross country are not the most attractive jobs. When delays and congestion are added in, the job becomes less appealing. Eleven hours on the road is bad enough, but waiting many more until your turn comes only builds the frustration.
There are 11 million job postings today for less than 8 million unemployed. It would seem anyone who wants to work can get a job instantly, but there are mismatches between what’s available and what potential workers want. There are geographic mismatches as well. There is also the impact of Covid-19. Certain jobs risk getting sick more than others. Some have preset conditions workers choose not to meet. Some reflect burnout from existing workers. Nurses, aides, and other essential healthcare workers have been exhausted by the impact of Covid-19. Replacements can’t be found. Some of these problems will disappear in weeks, some will take months. A few might last a lot longer.
All this is a prelude to what is going to take place in Washington this week. Democrats could fund the government until the end of this year, extend the debt ceiling, pass a $1.2 trillion infrastructure bill as early as today, and pass an even bigger $3.5 trillion social spending bill.
Or they can do none of the above.
There are 50 Democratic Senators. Vice-President Kamala Harris can break any tie. In the House the Democrats also have a majority, but a slim one. Thus, if unified, they can pass almost anything. So far, however, they are only “mostly unified”. Mostly isn’t 100%. They need 100%. That requires compromise. It means Joe Manchin and Bernie Sanders must agree. It means progressives in the House who insist that the $3.5 trillion spending bill comes first without any cuts could scuttle the bipartisan infrastructure bill scheduled for a vote today.
As for extending the government funding and debt ceiling, Democrats can do both unilaterally. Republicans might allow a short-term extension of government funding but won’t back a debt ceiling increase. Democrats can pass a debt ceiling increase, attaching it to one of its spending bills making its way through a process called reconciliation requiring a simple majority.
In other words, politics is trumping common sense. That has been the case in Washington for years and is only getting worse. Regardless of the outcome, Congress and the White House are tackling too much at one time. That almost guarantees that whatever passes, assuming something does, will be much more flawed, and likely more expensive, than it should be. Almost certainly, especially as it relates to the $3.5 trillion package, Congress is going to be asked to vote on something that will be so altered and mutilated over the next few days that no one will have a chance to see or read what they are voting for before they actually vote.
Let me just offer one example. A centerpiece of the Democrat’s plan is fully paid for 2-year community college. OK, sounds like a great idea. A perfect training ground for high-paid jobs. A way for inner city kids to get a real head start. But what constitutes a 2-year community college? There is an obvious answer; we have many in place now. But if 2 years of post-high school is free, what happens to traditional four-year schools? Probably a lot go out of business. Some may convert to community colleges, at least for the first two years. Why should students pay $30,000-50,000 per year if they can get the first two years for free, courtesy of the government? Who accredits community colleges? Clearly, some will be effective, and others won’t. This will be another big new government entitlement. Heard of Medicare fraud? There will certainly be community college fraud as well. I could make the same arguments regarding preschool.
I am not advocating for or against any of these programs. I would, however, like to see them designed in an orderly way that makes these programs as efficient as possible. I want to make sure the benefits go to those in need, not those first in line. That isn’t likely to happen with legislation that is rushed and cobbled together to meet every dissenter to get unified Democratic support. The issue may be less about the programs within the package but rather what the right costs should be.
Look at climate change. Before handing out credits to every startup that wants to build “clean” vehicles, why not consider a carbon tax. The polluters pay; those who reduce greenhouse gases receive. The tax can be revenue neutral, putting incentives in the right places. For political reasons that doesn’t happen; big giveaways gain votes, taxes don’t.
Enough of my rant. Congress is going to do its thing this week or next or the week after, and we investors will have to react to whatever happens. The odds are that something happens, that the size of the total package will be less than currently requested, that corporate taxes will go up a bit, that wealthy investors will pay more, and that future deficits will keep rising, probably at a somewhat accelerated pace. All this works if interest rates stay near zero. For that to happen, the supply chain problems must be resolved. They will, the only question being when.
The bigger issue is whether there are longer-term shortages, most specifically in labor and shelter, that push inflation higher than currently projected. That is the big risk going forward. We won’t know the answer for another year or so until the pandemic winds down and life returns to some semblance of normal. If the Fed is right and core inflation remains close to 2%, the bull market continues for a long time. If, however, systemic inflation is closer to 3% or even higher, it will be a world that could cause significant turmoil in financial markets. So far, there is a firm bet on the former. Rather than take sides, we will wait for more evidence to unfold.
Today, Gwyneth Paltrow is 49. Steve Kerr turns 56.
James M. Meyer, CFA 610-260-2220