To my clients:
It was a down week for North American stock markets with the Canadian TSX finishing down 0.5%; the U.S. Dow Jones Index down 1.1%; and the U.S. S&P 500 down 1.4%.
Two topics this week: inflation and the material announcement by the CDC.
As forecast by the U.S. Federal reserve, and as I’ve previously written about, inflation is coming through loud and clear in recent data releases. The U.S. Consumer Price Index was up 4.2% year-over-year, while the Producer Price index was up an even greater 6.2% year-over-year. Both levels are well in excess of the Federal Reserve’s long-term target of 2.0% - in fact, the levels are 2x and 3x higher respectively! What’s going on here? Is inflation beginning to run rampant? Let’s have a look…
The first, and by far, most important thing to note is these monthly data points are measured on a year-over-year basis. Well, as we all know, April of 2020 was a disastrously poor month for economic data. To call the first half of 2020 a short-lived depression would not be overstating the severity of the economic data. When recessions happen or, worse, depressions, the associated price pressures are deflationary – not inflationary. As such, inflation metrics for the next handful of months are going to be measured against extremely weak year-ago comparables. This is why the Federal Reserve has of late been consistently stating it expected a “transitory” spike in inflation. We are clearly in the midst of said spike.
The more important question is whether inflation will be sustained at levels above the 2.0% Fed target (let alone the 4.2% and 6.2% levels just reported for 2021). The Fed doesn’t believe so. Myself, I’m not so sure. The massive amounts of monetary and fiscal stimulus pumped into the global economy this past year means there is more money competing for available goods. To my mind that has to put at least some upward pressure on prices. To what extent remains the question – particularly in light of downward pressure exerted by ever-improving productivity owing, in large measure, to increasing automation.
However, a bigger point is this: the Fed has explicitly stated that, in spite of transitory inflation, it will continue to keep rates low even if inflation normalizes in the second half of 2021 yet still runs above the Fed’s 2.0% long-term target. Why? Because, for years, inflation has persistently come in below the 2.0% target and the Fed now wants to see inflation run above the 2.0% target for “some time” so as to balance long-term measures around the 2.0% target. In other words, the Fed wants inflation to average 2.0% over time, not merely achieve it.
Further still, the Fed has explicitly stated that it wishes to see employment conditions return to pre-pandemic levels before raising rates. While employment has certainly been improving the past many months, the jobs hole created by last year’s shuttered economy was massively deep, and there remains much work to do.
And yet even further still, in the prior two recessions before the pandemic (i.e. the 2001 tech wreck and the 2008 financial crisis), the Fed cut rates and kept them low for far longer than most expected. In both cases, time frames measure in years, not months. I see little reason to suspect this time will be different – particularly in light of the Feds explicit intent to keep rates low.
Bottom line, inflation concerns and the spectre of higher interest rates led to some of the market weakness seen this week, but for the reasons stated above, I’m skeptical rates will be moving higher any time soon. In other words, the market action this week is best viewed as “noise” that should not dissuade investors from adhering to their long-term investing strategies.
Moving on, I’d be remiss if I weren’t to quickly comment upon the game-changing recommendations from the U.S. Centre of Disease Control yesterday. In the most overt sign yet that the U.S. is surging toward a “return to normal” the CDC indicated that fully vaccinated individuals need not wear masks nor socially distance – either outdoors or indoors. I’m not going out on a limb when I note that this is what we all are anxiously awaiting. The CDC, citing scientific data, indicated that risk of infection to fully vaccinated individuals was miniscule and that the risk of serious disease was bordering on non-existent. Equally important, the risk of spreading Covid-19 to other non-vaccinated individuals was also miniscule. Such news will further support the already strong economic recovery underway in the U.S.. While the vaccine rollout in Canada is somewhat behind the U.S., it nonetheless is accelerating. Hopefully our country will see a similar pronouncement in the months ahead.
That’s it for this week. All the best and stay safe,
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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