Vitaliy Katsenelson’s Contrarian Edge: Higher inflation will push Americans back to work and cool speculative markets
Investors now are experiencing a perfect storm of inflation in the U.S. Perfect storms are generated from seemingly small factors. Each on its own may not be particularly significant, but the combined result is an event that significantly exceeds the sum of the parts.
Inflation is always caused by too much money chasing too few goods. This is how the “too much money” side looks currently: During mandated pandemic shutdowns, the U.S. government dropped money on anyone who could fog a mirror. This happened while (and because) big parts of the economy that are normally large cost items in consumer budgets — travel, entertainment, restaurants — were shut down. When your income doesn’t change or arguably increases and your expenses decline, your savings grows. Pockets stuffed with cash resulted in healthy demand as the U.S. economy reopened. Consumer savings were also helped by the freeze on student loan payments and the eviction moratorium.
Most of the action now is happening on the “too few goods” side. The global economy is a complex machine that needs to be in a state of constant flow. Once the system is interrupted, it takes time and a lot of effort to get it moving again.
For example: Shipping containers are one of the most important technological inventions of the 20th century. Their standardized size allows goods to move effortlessly on different modes of transportation (trucks, trains, ships) across the world.
There is a container shortage in the U.S. today. Why? There are many reasons: As U.S. production shut down during the pandemic and the Chinese economy was humming, Americans were consuming goods and not sending anything back to China. Containers got stuck at U.S. ports.
That was just the beginning. Now containers are stuck at their end destinations due to a shortage of truck drivers. Ports are slow to unload ships due to labor shortages, work disruption due to COVID, and equipment shortages. Ships loaded with containers are waiting to be unloaded, and this leads to even more container shortages, effectively taking supply out of the market. Companies suffering from inventory shortages are in turn hoarding containers to store extra inventory.
The global supply chain is complex. Few manufacturers produce every part that goes into their finished products. They rely on dozens, often hundreds, of manufacturers, many of whom have parts and raw materials stuck in the container bottleneck. Today your ability to produce goods is as strong as the weakest link in your supply chain.
Containers are just one example of disruptions on the supply side. In many ways and in many places, the result of COVID was effectively a reduction in the supply of just about everything.
I know it doesn’t feel like it, but inflation is both a feature and a bug of a normalizing economy. Higher prices signal to suppliers of goods and labor that we want more of what you’ve got. Higher container leasing prices will make storing inventory in them expensive and also increase production of new containers. Higher wages will bring truck drivers back on the road again.
The coming months will be tough. I am optimistic, because capitalistic impulses are programmed deeply into human DNA. We are selfish creatures, and selfishness is going to save us. Millions of tiny selfish decisions in the pursuit of personal profit maximization will return things back to not normal, but a new normal.
This new normal will reflect a truth about the pandemic — it accelerated the future. We’ll work from home more, go to the office less. We’ll order more things and food online. Leisure travel may not change much, but business travel will compete with Zoom. The global economy will go through de-globalization; more manufacturing will move away from China and back to the US and Europe. Inventories will become a bit less “just-in-time.”
Longer term, the present labor shortage will likely result in more automation — equipment never sleeps, talks politics in the office, or asks for a raise or healthcare benefits.
In addition to higher interest rates, the most immediate economic risk I worry about is inflation turning into stagflation. Higher prices result in significant reduction in consumption.
The one disruption that really puzzles me is the labor shortage. Millions of U.S. jobs are unfilled. I hear stories of Starbucks stores being closed due to a lack of workers. Every service that has a labor component has gotten worse –– be it restaurants, ridesharing, or pharmacies.
For a while there was an easy explanation: People were being paid not to work. Yet I would have thought that after the payments stopped they’d return to work. This has not happened as much as I thought it would — yet.
Why this is happening is likely the sum of many factors. I can only partially agree with the rhetoric, “I decided not to work because I hated my job and my pay,” a litany we often see repeated in the press. You can do this only until your savings runs out. Before the pandemic, Americans, especially those in low-paying service jobs –– the core of the current labor shortage — did not have much savings. Many lived paycheck to paycheck. The pandemic has helped many people boost their savings, but eventually they will chew through that and this will normalize the labor market.
This is my main theory explaining the labor shortage. There are other theories: early retirement by baby boomers; migration of the labor force; newly minted bitcoin millionaires who don’t want to work, folks who sold expensive houses and bought cheaper ones and are sitting on comfortable nest eggs.
Much of this newfound wealth has made its way into the stock market, cryptos, real estate, NFTs, and anything else that can be bought and sold. As the final elements of the pandemic stimulus roll off, people will either need to go back to work or sell assets to pay for expenses — and speculative markets will run out of greater fools. Rational thinking and conservative portfolios will be rewarded again.
How do we invest in an inflationary environment? Read this article
Vitaliy Katsenelson is CEO and chief investment officer of Investment Management Associates. He is the author of Active Value Investing: Making Money in Range-Bound Markets, and The Little Book of Sideways Markets.