December 3, 2021
Market Insights: Weekly Update (December 3, 2021)
The Economics of Pandemics
Please see below for the recorded seminar with Jeff Finkelstein, Vice President, Director, & Portfolio Manager:
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Everyone, thanks for listening again this week-- another variant and more market volatility. This week I'm going to concentrate on the economics of pandemics.
Now, as we all know, for the past two years, COVID health risks, but more importantly than the government response to the health risks have dominated the economy and the markets. So these are the basic steps.
Number one, dominance of health policy. Factories close, services close, unemployment is severe.
Two, governments compensate, provide income supports, families and businesses. Central banks lower rates.
Three, many-- most consumers conserve cash and they build wealth in this environment. They can't spend. They can add to their savings. And they're and they get asset growth from house, equity, portfolios because of the low rates. Suppliers cannot supply, either forced to close, staff won't come in, volatile supply chain. And then things turn around as they have been recently when services are allowed to resume, a giant rush of new demand.
Manufacturers, transportation networks are unable to keep up, supply shortages and inflation result. Central banks-- and now we're moving into steps 7 and 8. Central banks get concerned about all the inflation and they prepare to remove stimulus and raise rates. And then that, of course, the markets question if the economy can absorb these rates. Spoiler alert, they can. But that doesn't mean there's not going to be volatility.
On top of all this, each new-- every time a new variant is concerned and there's worry to worry about health policy as the government responds so we start to kick off the cycle again in different ways.
A little bit about the impact of variants. So here is a chart of the pandemic era going back to April of last year. Those little circles over there reflect each variant comes up. So each variant comes up-- if you look around June, that's the Delta variant. Each variant comes up, short-term traders go into a flap, the market goes down for a little while, same thing is happening right now. And they're all buying opportunities because that's your direction. Anyhow, market flapping now. That's what we're seeing.
In the big picture, what's really interesting is very strong economy. This is dealing with unemployment claims-- 52-year low. So this chart goes back to the 1960s. So in the US data is provided on the number of unemployment claims each week. That number, as you can see, is falling extremely sharply. Nobody's getting laid off anymore. Workers are now a scarce and valued commodity. And workers and their families, who are consumers, benefit from that. They do, high savings, lots of employment, rising wages, all this good stuff, and they want to buy stuff to support the at home lifestyle with each variant once again adding to the confirmation that staying at home is a good, safe thing to do.
This is interesting. This goes back-- this looks at consumer spending all the way back to the early 1990s. That's the spending trend before the Great Financial Crisis, especially for Americans this was economically traumatic. Prices of almost every home fell by a quarter to a third. It was extremely damaging and you can see from that purple line over there that the level of spending stabilized, but it stabilized at a fairly depressed level till now. We finally caught up.
So the implication of this, if interpretation is correct, it-- is that the American consumer, the American economy has finally regained as confidence after more than 12 years in the wilderness, that the kind of boom and expectation in growth is going to keep on going at a level we have not seen for a long, long time.
Well, all this stuff creates inflation in goods. The blue line is inflation in goods and white in services. See, service inflation was back to the late 1990s at a fairly moderate clip. And, quite frankly, even with the pandemic, there's not a whole lot of change. Blue line, manufacturing generally a little bit below, has, up until now, suffered from or benefited from low wages, globalization, things like that. They require-- however, they required a well-functioning supply chain and facilities and that's breaking down right now.
The demand for goods here is shown right there. So that's where inflation is coming from. It's not coming from more expensive trips to the hair salon. It's coming from buying hard goods.
Same thing in Canada. And using US data, Canada-- Canadian data very similar-- booming consumer demand, supply shortages, Canadian labor market is tight. As of last week, a million jobs are unfilled.
Well, central banks are getting tough. So here's the forecast of the Fed and when they will be having future rate increases on the short end. Now, big change this week, very significant.
So up until now, he was considered dovish, supportive of allowing the economy to grow so that all of the lower income people could take advantage of that, allowing the economy to run hot, well above expectation. That's all gone. He's now an inflation fighter, historically following the key mandate-- the economy is not going to run hot. Inflation should not be treated as transitory. So they're cutting back their bond buying. Expectations is they will start raising their rates by the spring in the US. They're expecting it the next year, a day three rate increases of about 0.75%.
RBC forecast about the same, although it could be higher. We'll have to see.
Bond markets. Now, what's happening in the bond market-- in the bond markets-- the longer term bond markets is different than in the short-term rate markets. They're actually staying fairly low. One of my favorite games in the office is to look at new issues coming across our desk and seeing how fast they sell low. It's quite amazing.
This week Hydro Quebec bond paying 2.7%-- that's it-- until 2060. So that's almost a 40-year bond paying 2.7%, sold out in a record-breaking eight minutes. That's breathtaking. But I guess compared to government bonds over the same duration, which pay under 2%, this is a great deal. Point here is that there's a lot of long-term buyer confidence that inflation will be under control.
That rise over there in the government 33 rate-- this was the little panic that brought portfolios down a little bit in the months of September, October. That's because inflation was picking up and the Federal Reserve did not seem to want to respond. Now they're responding and now that's it. That seems to be the peak of rates-- low rates.
So let's wrap up. Two more slides.
So how do you invest during moderately higher inflation? So the main estimate-- US inflation at about 4.4, next year going down to 2.5, the year after-- RBC thinks about 3%. Well above the 2% seems to be the consensus. So some inflation, not a lot, but some.
Now, from an equity perspective, companies have to grow profits and dividends faster than inflation. So if inflation goes up a bit, then your hurdle rate to beat inflation goes up a little bit. But it's not significant inflation and it's mostly-- and it's most doable for many companies.
So what are the favorite industries when an interest rate low-- or low, inflation is high? Infrastructure, real estate, financials, commodities. Payers of growing dividends are especially favored.
Now, beyond that, long-term rates, looking at the long end-- just discussed-- staying low supports technology and that includes the innovative growth companies, consumer discretionary, and communication sectors. That's how we're investing.
Final thought. How long will this how long will this inflation persist? Well, the quote from George Santayana, famous historian says, "History does not repeat, but it rhymes." So in periods of time where we have great uncertainty, we look to history to history for clues as to what could happen. And the closest analogy we have right now is the post-World War II era.
Now, during the war, supply of consumer goods dried up. Everything went to support the war effort. There was no consumer demand, there was mandated rationing. You couldn't buy dishwashers or cars, could-- none were produced. Severe repression, like some of the economic rules, restrictions that we had earlier on.
After the war, consumer demand exploded and then, like now, goods consumers could not initially meet the demand. It takes time to convert a tank factory. Even worse, about a third of the workforce, that would be all the people in the military and support workers, were effectively laid off. Sorry, guys, you're out of a job. Go find a job.
The expert economists of the day forecasted certain disaster. A third of the workforce appearing and no supply? Anyhow, how it got resolved then and will likely be resolved now is in the business ecosystem. People want to make profits and move quickly in that direction.
It took the business ecosystem two years. Now, during the two years, there was high inflation, admittedly. Then it came to an end. It took a long period of time. Supply shortages same kind of complaints that we have right now, even to a greater extent because they had greater problems back then. It took about two years to reabsorb the soldiers back to domestic jobs. Unemployment went down to 3.6% after two years, very similar to current rates. And to retool the factories.
The important thing to understand in a longer term perspective is that after a business-led transition period, inflation settled, the economy strengthened, and the markets confidently settle into an extended, multi-year boom that was the '40s, '50s, and early '60s. Perhaps, if history is rhyming, that might be a good forecast lesson for us.
On that note, I will sign off. I wish everybody a happy weekend. Once again, look forward to all of your questions and comments. Have a great weekend.