Is the Inflation genie out of the bottle?

November 2021 Monthly CiN-sights

Global equity markets recovered from early volatility to record positive performance for October, as all three major US indices hit new record highs courtesy of a strong earnings season. The ASX200 was unchanged over the month. Heightened concerns on rising inflation lifted the volatility, as corporates and central banks acknowledged a number of ongoing pressures remain. The recent Q3 AU core CPI release was at the highest level in 6 years.

The US Federal Reserve has maintained the view that current elevated inflation is largely reflecting transitory factors as economies readjust to pandemic issues, nevertheless in the latest FOMC meeting they lifted both their headline and core inflation estimates for CY21 and CY22, implying the impacts may last longer. The challenge will be what action major central banks take: rate hikes to temper any inflationary impact after a period of unprecedented expansionary policy setting, or delay on tightening and risk letting inflation overshoot for a more prolonged period.

In our recent December quarter outlook we highlighted feedback from companies globally regarding ongoing supply chain issues for semiconductor chips and immediate goods, coupled with shipping delays that have pushed prices up. Additionally, we have seen numerous commodity prices continuing to surge, with the Bloomberg Commodity spot index hitting an all-time high. Oil and gas prices have spiked with energy shortages in China and the EU, likewise, food prices are at the highest price in real terms since 2010-11, raising concerns about consumer food inflation.

China, as the world’s largest exporter, has just printed their highest producer price (PPI) increase since records began, as power and input prices soar. The focus will now be whether these higher costs are passed onto customers. A similar impact in Europe as energy shortages intensify the squeeze on some metal prices, with one of the largest global zinc producers Nystar announcing production cuts of up to 50% due to the surging energy prices, which has lifted zinc prices to 15-year highs.

The supply chain issues were evident in the US reporting season, with several manufacturing companies; P&G, Kimberly Clark, 3M, Caterpillar and GE citing higher commodity input prices and freight costs. A number of these producers’ signalled price increases will occur for some products. Amazon and Apple both flagged several billion dollars of additional costs, courtesy of supply constraints and labour shortages. Global auto producers continued to struggle with semiconductor shortages in Q3, Volkswagen saying it expects this trend to continue into 2022.  

Undoubtedly the consequences of Covid-19 have impacted global manufacturing and created bottlenecks. The initial reaction to the pandemic saw buyers cancelling orders of intermediate goods, and then producers have struggled to ramp up supply as strong demand returned. The latter has been impacted by staff shortages due to Covid-19 infections, plus disruption to global shipping routes with a combination of restrictions in ports (China and US) and shipping lanes (Suez Canal) creating distortion in available shipping containers.

Consumer driven inflation is a further issue raised by economists, with one outcome of the pandemic being savings rates have bounced aggressively across developed economies. They expect that a proportion of these savings will be utilised as economies reopen and consumers resume their normal spending patterns (entertainment, hospitality and personal retail). Furthermore, unemployment rates in the US, UK and AU have continued to trend down supporting the increasing household consumption and increasing wage inflation theories.

Source: J.P. Morgan Asset Management Guide to the Markets – Australia, 30 September 2021

The inflation trajectory in this cycle is still unclear and will continue to be impacted by Covid-19 outbreaks disrupting supply chains. We watch for evidence of wage growth and pricing pressure within the system. The inflation advocates point to changing structural factors such as an ageing global workforce (less cheap labour) and waning globalisation being longer-term challenges for central bank decision-makers.

Despite these growing inflation risks we retain our overweight to developed market equities (AU, US and EU). We believe the asset class will continue to be supported through the December quarter by the strength of the economic and earnings outlook. The Q3 earnings season in the northern hemisphere has started strongly with the majority of S&P500 company results beating analysts EPS estimates. Overall earnings growth is now forecast at +33%. Similarly in the EU, Q3 earnings are expected to rise circa 50% YoY.

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