As I drove home from work last Monday evening, I noticed cars backed up for two and a half blocks on Battlefield Boulevard. Performing a “rubberneck” routine, I saw they were all waiting to pull into the 711 to fill up their tanks with gas. It reminded me of the 70’s when I drove my dad’s Ford Pinto to school each day being thankful that it rarely needed gas.
Maybe you also remember the gas lines of the 70s when the Organization of Arab Petroleum Exporting Countries (OAPEC) proclaimed an oil embargo. By the end of the embargo in March 1974, the price of oil had risen nearly 300%, from $3 per barrel to nearly $12 globally; US prices were significantly higher. The embargo caused an oil crisis, or “shock”, with many short- and long-term effects on global politics and the global economy.
What we now know caused the recent “rush to the pump” was a cyber-attack on the Colonial Pipeline distribution process to the Southeast United States. This has now been corrected but it demonstrates the vulnerability of the energy sector to cyber-attacks and to what happens when demand picks up and supply is lacking.
Another recent shortage is that of computer chips which is resulting in excess demand and supply deficiencies. As technology has advanced, semiconductor chips have spread from computers and cars to toothbrushes and dryers. As with gasoline, if the shortage of chips continues, prices of goods will begin to move higher. The question is, how fast and how high?
The subject of rising prices is continuing to weigh on the economic outlook. There is much discussion as to whether the recent rise in commodity prices is transitory or a precursor to what may be coming. The supply-chain challenges that have hit other industries including poultry and lumber are concerning. Expectations that demand will continue to pick up on these products and others add to the supply/demand mismatch and concern of inflation.
We have talked about the three legs of the stool for recovery that may continue to drive stock prices higher. They are the government stimulus, the vaccine, and the third is pent-up demand. The three of these together will most likely result in a continuation of the V-shaped recovery that the economy is experiencing. Whether they will lead to continued inflationary pressures is a subject that is being hotly debated. This heated conversation is causing some to believe that the federal reserve may need to tighten policy by raising interest rates and taper their purchases of government bonds.
However, central banks have indicated that they will not tighten policy in response to what they are calling a “transitory increase in prices.” Federal Reserve Chair Jerome Powell has repeatedly stated that the indicators reflecting a rise in inflation are “largely reflecting transitory factors.”
Last week’s pullback in the stock market is believed to be the concern investors are having about inflation becoming a more permanent part of the economic outlook. The Consumer Price Index (CPI) number that came out was up 4.2% compared to a year ago. We did see stock prices rebound later in the week but there is a sense that investors will continue to look for trends that may indicate prices are on more of an upward path.
If we are about to experience a more inflationary period, a rotation for long-term investors to cyclical stocks is in order. We are seeing signs of this transition with the recent weakness in growth stocks that participated in the strong market in 2020. You have often heard that equity markets are forward thinking which may be causing this rotation to assets more correlated to inflation.
According to David Lebovitz, Global Market Strategist at J.P. Morgan Asset Management, the outperformance of value relative to growth has historically exhibited a strong positive correlation to inflation expectations.
More directly, the largest sector weights in value indices are things like financials, industrials, and energy. According to Lebovitz, the earnings of these types of companies generally tend to be highly levered to the overall pace of economic growth. Bottom line: value stocks tend to outperform their growth counterparts when inflation expectations are rising, as higher inflation should in theory coincide with stronger earnings growth.
Much of the last twelve-month rise in the stock market resulted in the expectation that the economy will reopen and life will return to normal for everyday citizens. Daily I hear of friends and clients that plan to up their travel schedule to make up for trips not taken last year due to the pandemic quarantine.
United Airlines announced it will add 400 daily flights in July for European destinations. The airline also said that summer travel bookings rose 214% from 2020 levels. My neighbor sold their house last month and had numerous offers the first weekend of showing. They accepted a cash offer significantly above the asking price.
All of these financial phenomena will continue to be observed by myself and many other intelligent, long-term investors to see whether these types of inflationary pressures are transitory or a more permanent part of our economic landscape. As always, we will continue to keep you informed with our financial planning services and up to date on what we learn, observe and anticipate.
If you need a co-pilot for this and other types of financial turbulence, your best bet is a Certified Financial Planner™ who offers efficient financial planning services. If you have not engaged with a CFP yet, please reach out to Tull Financial Group on 757-436-1122 for wealth management services – we have a team of experienced Financial Planners who are well versed in and prepared for the ups and downs of investing, so that you can sit back, relax a little, and enjoy the ride.