- Scott Poore, AIF, AWMA, APMA
In the classic film "Dead Poets Society," new professor and returning alumnus John Keating urges his students to mind the Latin words carpe diem (seize the day). There are probably not a lot of us who even knew what those words were before seeing the movie, but Robin Williams certainly made those words become mainstream with the popularity of the movie in 1989. Today, investors have something else to seize - Inflation. Prices are rising and there's no clear trend that they are easing. At some point, the Fed will be forced to deal with inflation and that will lead to tapering bond purchases and raising the Fed Funds rate - perhaps sooner than previously advertised.
By the way, the poem that Keating has Mr. Pitts read when introducing the audience to the term carpe diem is a poem by Robert Herrick titled, "To the Virgins, to Make Much of Time." Good words for such a crazy time in which we are living:
"Gather ye rosebuds while ye may,
Old Time is still a-flying;
And this same flower that smiles today
Tomorrow will be dying.
Let's look at what we're seeing this week in the markets...
Roll On Inflation, Roll On. If you're a country music fan you've probably heard the Alabama song, "Roll On 18 Wheeler." I've borrowed the song's title as we saw Inflation increase, yet again, in July. Wednesday, the Consumer Price Index increased 0.5% in July, as expected. While that is lower than June's +0.9%, it's still an increase and now 5.4% higher than this time last year. We saw May's CPI number rise at a lower rate compared to April, but then June's number showed that inflation regained steam. Thursday, the July Producer Price Index showed an increase of inflation for producers of +1.0%, which was higher than the 0.6% expected. July's PPI matched June's print. It is reasonable to expect that the increase in prices for producers will eventually be passed on to consumers, causing the CPI to continue to increase. So far, inflation is not showing signs of being "transitory." Inflation has been a clear concern of corporations as mentions of inflation rose 900% in quarterly earnings calls on a year-over-year basis. According to the Atlanta Fed, companies surveyed by the bank expect inflation to increase 3% over the next 12 months. The lone bright spot in July's CPI report does show that Used Car prices and Rent decelerated. This has been a strange phenomenon over the past few months as new car lots are empty due to chip shortages, causing demand for younger used cars to rise. Rent prices slightly decreased, but overall Shelter prices continued to rise. As long as the economic fundamentals remain positive, it's best to keep equity exposure in portfolios to offset the effects inflation will have on real returns.
Infrastructure Bill or Bar-B-Que Dinner? If Washington, D.C. has proven anything over the past century it's that they never let a crisis go to waste when they can pack a lot of excess pork into a bill. This country has been in desperate need of infrastructure spending for the better part of 4 decades. Congress passed on infrastructure in 2020. The current Infrastructure Bill recently passed by the Senate awaits passage by the House under budget reconciliation before it makes its way to President Biden's desk. So far, it looks like it will make it through the remaining hurdles in its current form - but, time will tell. According to the OMB, the $1.2 trillion bill provides for government spending toward "infrastructure." However, a quick analysis of the bill shows only $408 billion in spending on such things as roads, bridges, electric grid, rail, broadband, drinking water, and transit. That much is easy for Americans to support. However, the remaining $792 billion (66%) is for other items that have little-to-no relevance with infrastructure. Included in the bill are many hidden taxes (such as the mileage tax) and regulations that, on top of the government waste, that would add costs to consumers. So, consumers may experience higher taxes and higher inflation, all at once. This would prove a hinderance for economic growth.
Everything Else That's Going On. Meanwhile, we brought up what was happening to bond yields last week and that the bond market could be telling us something. Our premise was that the decline in the yield on the 10-year Treasury Bond was forecasting lower economic growth ahead, primarily due to increased COVID cases and potential lockdowns. We estimated two scenarios - Best Case (slowdown in growth) and Worst Case (COVID lockdowns/restrictions). It it would appear for now that the Best Case scenario might be in order as bond yields have risen 14 basis points (77%) since our last writing and the impressive jobs report last week affirms the recovery in the labor market. Speaking of the labor market, this mornings Claims came in lower as expected with only 375k jobless claims. That's the 3rd consecutive week with a drop in claims and 14 of the last 18 weeks with a weekly decline. That's good news for future growth prospects, but perhaps bad news for growth/momentum stocks. Since yields started rising last week, the Russell 1000 Value Index has out-performed the Russell 1000 Growth Index by 78 basis points. Prior to last week, growth stocks had out-performed value stocks for the last 2 months. We could be seeing another shift back to cyclicals as higher yields makes growth (esp. Technology) stocks look expensive.
There is some positive news on the COVID front as cases are showing some early signs of peaking in the U.S. This weekend was the first since June 19th that cases and deaths decreased week-over-week on both Saturday and Sunday. Because of the way certain states record their data, Tuesday is sometimes a "data dump" day for COVID metrics, but this past Tuesday was a lower day as cases decreased 8% versus last Tuesday when cases were making fresh daily highs. Wednesday and Thursday did not follow suit. Reproduction rates of the virus are also declining in key states with high Delta variant cases - FL, TX, TN, AR, MO, & LA. We could be getting close to a plateau, but again, time will tell. Vaccination rates have risen over the last few weeks. In fact, nearly 51% of the U.S. population has been fully vaccinated for COVID. According to the CDC, the average vaccination rate for the flu in the U.S. is 42.3%. So, we're well ahead on COVID vaccinations than what we would normally vaccinate for the average flu season. There is a lot of "misinformation" being reported out there in the media and on social media. The best way to look at this virus is by looking at the data.