How Transitory is Inflation?

Jul 16, 2021 | Nick Scholte


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"Pandemic Idiosyncrasies" - much of which appear to be automobile related - account for nearly all of the very elevated month-over-month inflation measure. Underlying inflation looks broadly in line with the past 25 year average.

To my clients:

It was a down week for North American stock markets with the Canadian TSX finishing down 1.3%; the U.S. Dow Jones Index finishing down 0.5%; and the U.S. S&P 500 finishing down1.0% .

Three topics this week: inflation; broader economic data; and virus trends.

Unquestionably, inflation is surging to uncomfortably high levels. Headline year-over-year inflation came in at 5.4%. While the caveat still applies that this number is in comparison to depressed year-ago levels, it is also noteworthy that the month-over-month inflation figure (i.e. inflation from May 2021 to June 2021) came in at 0.9%. In other words, a broad basket of consumer goods cost roughly 1% more in June vs May of this year (here it should be noted that the typical month-over-month inflation rate over the past quarter century was a touch under 0.2%). If such rates of inflation are sustained, the negative economic impact would be profound. To be sure, certain prominent economists are starting to question whether these inflation rates will indeed be transitory as the U.S. Federal Reserve repeatedly states, or if there is a more insidious inflationary trend building. At this juncture I lean toward the Fed’s point of view that the spike in inflation is a result of supply chain bottlenecks as consumer demand ramps up. For example, it is widely known that there is a global computer chip shortage in the automobile industry. This shortage has led to scaled-back production at auto manufacturers around the world. But the reduced production comes at a time when demand for vehicles is surging as economies re-open. What happens when demand increases while supply decreases? The answer is higher prices. And in an internal report published today here at RBC, it was shown that about half of the excess month-over-month inflation owes to the auto industry alone. The remainder of the excess attributes to other “pandemic idiosyncrasies”. Stripping out these idiosyncrasies, underlying month-over-month inflation as calculated by RBC came in at a touch over 0.2%. In other words, underlying inflation might be modestly higher than the 0.2% average of the past quarter century, but not materially or worryingly so. Nevertheless, at this juncture inflation remains my number one concern as a Portfolio Manager, and I will continue to monitor closely for signs that it is not, in fact, “transitory”..

Regarding broader economic data, the numbers continue to be strong. Weekly jobless claims (the trend in which is RBC Dominion Securities’ preferred indicator of recession) continued its march lower (lower jobless claims are better) coming in at a new pandemic era low of 360,000 new claims for the week. Meanwhile, retail sales surged for the month of June (see the previous paragraph on “demand”), coming in 0.6% higher month-over-month. While I don’t normally reference retail sales in my weekly updates, given the focus on inflation above, I felt it would be useful to provide some context as to the drivers of said inflation. Absent inflation, surging retail sales would be good as it would be indicative of a strongly expanding economy.

Lastly, on the pandemic front, the Delta variant continues to propagate. In an interesting piece in the New York Times earlier this week, meta-analysis was cited which appears to show that while the Delta variant is absolutely more transmissible, it does not appear to be more severe in terms of expected health outcome. Previous to this study there had been concern, fueled mostly by anecdotal evidence, that perhaps the Delta variant was also more severe. But in digging deeper, it appears that increased hospitalizations associated with the Delta variant are a result of the increased caseloads the more transmissible variant is generating. In other words, Delta variant hospitalizations for the unvaccinated appear to be proportionate to other covid variants. More importantly, Delta-induced hospitalizations for the fully vaccinated are exceedingly low, and deaths much lower still. So, in my estimation, the pandemic is likely to further recede as an economic headwind. Unfortunately, it’s not likely to disappear entirely owing to the significant degree of vaccine hesitancy around the world. At this stage, it would require a yet newer variant that is: more transmissible; more severe; and, at least, partially vaccine resistant for me to again take defensive portfolio measures owing to covid alone.

Bottom line – in spite of inflation which is expected to recede, continued economic expansion is envisioned through the remainder of 2021 and all of 2022. Covid continues to recede as a concern.

That’s it for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
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