Inflation Inflation Inflation - Your Money December 10th 2021

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Well its official, the inflation cat is out of the bag. On Monday the street we received the latest stats on unit labor costs, (the key component used by the US central bank to gauge inflationary pressures) and for the third quarter ending September 30th, it jumped to 9.6% from 8.3% in the second quarter. On Friday, US CPI (consumer price index) came in at 0.8% compared to 0.9% in October. The annualized run rate is now 6.8%. Fortunately, the less volatile core rate (nominal rate minus food and energy) showed a more modest increase of 0.5% for November but even that annualized run rate is 4.9% well above the US central banks target of 2%.

Peaking under the hood to look at the major components in the CPI, autos and apparel saw the biggest increases and given the bottleneck in supply chains, Wall Street is banking on a more normalized rate next year courtesy of factories restarting plus the clearing of major container ship ports. Personally, I am not so sure. Yes, factories will restart once their raw material component inventories restock, but I don’t see bottlenecks clearing up any time soon. Structurally we have seen a dramatic shift in the supply chain. Warehouses are full because there are not enough truck drivers to make deliveries to retailers and end users let alone picking up from port terminals. Between rising fuel costs that hit drivers in the pocketbook and the aging of the work force causing retirement, there are not enough millennials and Gen X members taking up the slack. In fairness, thematically, it has not been viewed as a great career move especially with the prospects of automation and driverless technology. Realistically, the adoption is still years away, especially when you look at the number of Tesla crashes from owners that did not read the fine print before engaging auto pilot. But I digress.

My other reason for not accepting the general view that inflation will moderate in 2022 is a function of higher commodity prices and the new covid paradigm. Granted, work from home has caused a significant shift in how and where businesses source labor, but with everchanging virus variants, labor shortages will likely continue…again in my opinion. This could result in a sizable unit labor costs that will likely be passed on to the end buyer.

With respect to raw material prices, on a secular basis, the shift to greener technologies is creating a two-fold problem. Take automobiles for example. As demand for electric vehicles grows, the demand for copper and lithium are expected to grow. We could see both of those commodities to rise in the next decade. We also speculate a potential domestic supply squeeze for oil as more and more global companies divert future cashflow into renewable energy projects in lieu of drilling for more oil to replace lost production. Remember, even though the car is electric, it still needs oil to make tires, and it still needs asphalt to drive on. I recently read part of the newest OECD report on global economic growth and over the next 25 years there will be a significant population boom in the non-OECD countries with most of them increasing their per capita consumption of energy. That will put OPEC + Russia in the driver’s seat comfortably allocating hydrocarbons to nations willing to pay the highest price. Meanwhile just one minor natural disaster illustrates the longer-term supply line problems in Western Canada. Damn… I digressed again.

The point I am trying to make is I don’t believe we are in a temporary inflation blip. I think a lot of the bail out money handed out by governments will lead to an inflationary spiral. Plus, the source of those funds came from and is coming from a seemingly never-ending supply of newly issued government bonds. That will cause governments to run ever higher deficits just to pay the interest. We know for a fact ( and we speculate here in Canada) that US domestic savings accounts have never been higher, and the cash will find its way into the economy in the form of higher prices. New car prices are up 11% in the last year, used cars are up 31%. We also see it inching up in food and entertainment. Take Disneyland for example. The parking is now $75 per day. The one-day ticket is $159 per adult. In 2017 it was $124. Next year it is expected to rise to $164. I also just read their new Dream Magic Key Holder annual pass costs $1399 and it is already sold out! At those prices I am going to take a look at Disney stock which is currently trading at $153.

Speaking of buying, US and Canadian stock markets will end the week on a mostly positive note. Some late reporting tech stocks combined with an “as expected” inflation stat, sent the sellers to the sidelines. More importantly, the S&P500 hit another record closing high today thanks to companies like Norwegian Cruise Lines, Mastercard and CVS Health. However, it was not a broad-based rally this week and NYSE volume was down below a billion shares again. On the week, some notable names got clipped. Moderna down 9% this week, chip maker AMD down 8% and Tesla down 7%.

In Canada, most sectors moved higher led by energy and consumer stocks plus industrials and real estate. We note gold stocks had trouble catching a bid despite some merger action earlier in the week and some high-flying technology stocks hit a lot of turbulence. Nuvei down 37% this week, Hut 8 off by 14% and Tecsys dropping 7%. Ouch.

In earnings news names worth mentioning are Oracle and Broadcom. Both jumped nicely today yet are still trading at a respectable 22 times earnings. In Canada Laurentian Bank beat street estimates and is raising its dividend. Stock up 5%.

As for bond yields, even with the rapidly rising inflation, US investors still dipped their toes into the bond market taking the ten-year yield down to 1.47%. personally, I think it is crazy to buy a 10-year bond that is generating a negative real rate of return of over 4%. Perhaps, and I am speculating here, the producer price index may come in slightly below expectations (0.6% for November and reports on Tuesday) or a dip in retail sales out next Wednesday along with the official interest rate decision the same day. Again, I am skeptical and believe most investors are looking at the world through rose colored glasses.

In Canada, price action will likely be dictated via further prognostications from our central bank coupled with energy prices. Remember bank and insurance companies represent some of the largest companies on the TSX and both benefit from a rising interest rate environment. As for energy stocks, we have seen a recent pull back in natural gas weighted stocks in favor of oil producers. Crude as spent the last 10 days grinding back up from the sell off at the end of November and is back above $71 today. I see no real reason for it not to stay at these levels and even climb higher if further positive evidence emerges from the latest covid strain.

Beyond that we are working our way through tax loss selling and the Santa Claus rally which means stock that are trading below their January 2nd price will likely see more selling while those above will attract more buying. However, this can also be an opportunity if you follow the old “dogs of the Dow” strategy and start buying the best of the worst performing stocks for 2022.

Happy trading and stay safe out there.

Cheers Steve.

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Steve Bokor

Steve Bokor

Portfolio Manager