The Summer Begins...
Yes it does.
When I first started on Wall Street, 40 years ago, one of the first things I learned was that the summer was usually very slow. Little in the way of news. Markets meandered and volumes were down significantly. The people I worked with said this would be the best time to learn since people would have more time to explain different situations and I would have more opportunities to ask questions. Not true. In the summer of 1981 (my first summer) volumes spiked, markets whipsawed daily and there was little time for one on one instruction. I learned more that summer than I learned in the previous five months and they were lessons that stayed with me for my whole career.
Trial by fire was what they called it and what I noticed in the following 37 years was that summer was no different than any other time of the year. Big shots may have been in the Hamptons or the South of France or wherever the rich and powerful plunk down for the summer, but that didn’t stop large volumes or price fluctuations. We had triple bottoms, triple tops, bear markets, bull markets. You name it, the summer had them and everyone adjusted to it.
This summer should not be any exception. We have an economy that is going from 20 to 100 with very few stops in between. Money is flowing into the market and the economy at a record pace and if you remember Economics 101 that can only mean one thing; Inflation.
Now I have written about inflation several times before so this will be no surprise to my readers but I believe that there will be periods of hyper-inflation coming in the next few months unless some outside force (The Fed) steps in to mitigate it.
Trying to remember some of the key elements from my Economics classes back in the late ‘70’s is a fools errand. I can’t remember what I wore last Saturday but having worked in the industry for so long, some of those lessons have sunk in by osmosis. You can correct me if I am wrong but the most powerful element in an inflationary spiral is not commodity costs but labor costs. Rising wages will invariably lead to rising consumer prices and that will trigger pricing pressures for consumers.
I know, thats a little simplistic but I am all about keeping it simple and this period of inflation will eventually be wrapped around rising wages. It hasn’t really even been reflected yet in a lot of the data, but it will be.
Keeping it simple, employers in this country are having a hard time filling low to middle wage jobs. The first, and I still believe wrong, explanation is that the competition for employees is being complicated by some states generous unemployment benefits. Employers are competing against their own governments for employees. In New York, that might be partially true since its benefits are very generous, but for most states I don’t think so. Many states have turned off the Federal spigot and the $300 extra week that it entailed. These states unemployment benefits are barely over the poverty lines so why are they having such a hard time filling those job openings? Example; Tennessee pays a maximum of $275 a week and they have opted out of the Federal program so why are they having a hard time filling jobs. Granted the state minimum wage in Tennessee is $7.25 an hour, I doubt many businesses pay that so why are they having a hard time?
While I like to keep it simple I do believe this is a much more complicated issue with many facets seen and unseen. However, the government is your competitor argument doesn’t really wash here.
We may at some point figure out the reason for these imbalances but it is safe to say that there is a strong belief that you must pay a higher wage to get people back to work. Those higher wages will reflect on higher prices and the two month period where the Federal Government has actually acknowledged rising inflation will extend a lot further than economists are predicting.
With rising inflation in mind there are several possible outcomes and you can take your pick as to what will happen next. All have negative consequences.
The Fed will act aggressively. Rising inflation makes Fed Governors very uncomfortable. It, without an effective response, can derail an economy faster than anything other than a pandemic. Fortunately, the Federal Reserve has a lot of room to quell inflation. Raising interest rates can help but there is a point where higher interest rates have an incredibly bad effect on growth and it is a moving target for sure. My feeling is that we will see rates start to rise by the end of the summer. Done slowly, it may not have much affect but it will signal to markets that we do have a problem and the Fed is willing to act. Bad sign, good sign, higher rates will be an issue and it may help mitigate some of the growth ( or regrowth) of the economy. I do believe there is a safe level of interest rate expansion and that would be around the 3-3.25% range. Anywhere above that, we may be dealing with much more serious consequences.
Wage hikes to fill job openings will continue and businesses will have to raise end prices. Small businesses will be impacted most because their economic cushion is much smaller. Small retailers will have to pass along price increases and this will impact sales. Do customers go back into recession mode to save money or absorb the higher prices at small retailers and buy less? Or do consumers spend like drunken sailors and think less about prices and more about availability? I can buy it and it’s there so I am going to buy it, no matter what the cost. Will the end of restrictions and the newfound freedom of going out supercede the common sense of living your everyday life? Thats going to be a major question we will be answering over the next several months. I think early on it will be like the roaring ‘20’s all over again. Bars are open, travel is possible and people are working. I just hope it doesn’t end the same way.
Most people won’t care much about the impact on major corporations because, let’s be honest, most have not acted in our nations best interest. While they say they are doing their part, I’m not quite sure ringing up record profits can be considered in our nation’s best interest. Anyway, higher wages will creep in on major corporations bottom lines and they, as usual, will do what they can to maintain their profit margins. Either by raising prices (thats your inflation component) or making smaller packages with the same price point (unseen inflation). Their bottom line is more important because they answer to shareholders and shareholders want to see growth, at any cost.
One thing that is for certain, there will be more inflation. Most inflationary cycles stick around for a while and this one will be no different. The economy was thrown for a loop last year. We were on a large, sustainable run that was just stopped in it’s tracks and we are just now getting our footing back. The supply chains have been completely upended and even though I haven’t spoken about it, thats another inflationary pressure we have to deal with, they will need to be rebalanced as well.
What will all this mean for markets you ask? I have been calling for some corrective phase for a while. Am I wrong? Short term, obviously I was wrong. Since I have been on this “correction now please” phase the S&P has gone up 6%. Granted, thats not the worst call ever but if you listened to me, you would have missed that. I do stand by what I have said however. The economy is recovering nicely. Short term inflation is here and that in the short term is always good for stocks. Although, I see some valuations as out of whack with reality, most valuations can be explained as healthy for an economy at this point in a recovery. All sounds good but…
We are coming out of an unprecedented economic period. The US Government has pumped trillions of dollars into the system in one form or another. The Fed has kept a lid on rates and there is that free spending mindset I previously mentioned. Great. What about when the bills come do? When inflation is no longer that function of rising expenditures and profits? When the rest of the World opens up and their bills are due as well? When the spigot runs dry?
All situations that may happen in a few months or a few years but will happen just the same. The crack back to all this is a major pullback and the longer we go without a corrective phase the bigger the crack back. Don’t say I didn’t warn you.