For the middle age golf nuts out there, how good was it to see Phil Mickelson hold off Brooks Koepka and Louis Oosthuizen to become the oldest player ever to win a major after securing his second PGA Championship win this morning. He is 50 years, 11 months and 7 days old. There is hope for us old guys and gals yet!
But back to markets…
Every morning when I look to see what the overseas markets have done, it seems the reason for the big move is either: inflation is coming, and markets fall; or some data is released that shows perhaps inflation is not coming after all, and markets bounce. Then another inflationary data point comes out, and we’re back on the roller coaster. And that, my friends, is volatility. So today, I thought I’d give my 2 cents worth on the inflation genie that is front and centre of most investors’ minds right now.
First, I’ll talk about why there may be cause for concern that inflation could grip markets, and what the effect of this could be, and then I’ll talk about the opposite side of the coin; deflation, and why this may end up dictating the direction markets take over the next few years.
The easiest way to see whether investors think inflation is coming is to look at the bond market, and the most visible indicator here is the US 10-year bond yield. In the last 12 months or so, this yield has jumped from 0.5% up to 1.75%, and recently has drifted back to about 1.6%. So clearly, investors think inflation is coming. As I’ve written before, when higher interest rates are inputted into stock valuation models, growth stocks show lower valuations as more of their expected earnings are in later years.
We’ve all seen the fiscal and monetary measures Governments and Central banks have taken to try and stimulate the economy – in an effort to reduce unemployment, especially since the pandemic, where millions of jobs have been lost. If you go back to high school economics, you’ll remember the Phillips Curve, which says that with economic growth comes inflation, and that there is a stable, inverse relationship between inflation and unemployment. This means that to get unemployment down, the cost is inevitably some inflation. Governments have stated they are fine with that, given how low inflation has been in the past decade.
The other reason we have seen inflation in the past 12 months has been the supply chain bottleneck and breakdowns caused by pandemic lockdowns. This obviously increases input prices for goods to be sold and therefore appears inflationary. A good example of this is an apple farm in Bilpin – last year they struggled to get fruit pickers due to the lockdown (ie labour, ie input cost) and so the supply went down, which translates to higher prices when the demand stays flat.
Have you seen the word ‘transitory’ in your readings in the media lately?
Janet Yellen, the US Treasury Secretary, used it last week when asked her views on inflation. Massive fiscal and monetary support can’t last forever, and supply shutdowns will eventually re-open and get back to 100% capacity – and what then? If these are the reasons for said inflation concerns, and they don’t exist in a year or so, what do you think might happen?
And so, to deflation…
The biggest cause of deflation this century, has no doubt been innovation – both technological and disruptive. Technological innovation is easy to understand – just look at what you paid for your most recent TV and ask your parents what they paid for their TV 30 years ago – some of you will be surprised. Disruptive innovation should also be pretty obvious. New technology changes the way we buy things; and, nearly always, the outcome has been that you get a better product for a lower price. Think Amazon. Think Uber. Think QR codes that allow you to order your restaurant meal from your table.
Did you know that healthcare represents about 20% of GDP in the US?
Talk about an industry ripe for disruption!
Tele-medicine is the obvious innovation which is only just starting to take hold in healthcare, but innovation also present in medical research, where the costs are enormous. Our 2019 & 2020 Conference presenter Cathie Wood, from ARK Invest, recently reported that for every cumulative doubling in DNA sequencing of the human genome, which is central to discovering causes and therefore cures for disease, she is seeing a cost decline of about 40%. That is massive! She also mentions the 28% decline in the cost of battery packs used for electric cars – which simply has to lead to cheaper cars - both electric and petrol (no-one will buy petrol cars if the equivalent electric car is half the price) and probably sooner rather than later. This would then have ramifications for oil demand (and price), which could easily spill (pardon the pun) over into other commodity prices.
The icing on the deflation cake is if, and I repeat, if, such disruptive technologies do succeed, what happens to the (now) obsolete products of companies that have ignored the innovators??
I’ll tell you – that’s where fire sales of products come in. And they sure ain’t going to be at inflated prices!
So, there you have it – reasons to believe the inflation genie is out of the bottle, as economic growth and lower unemployment are deemed more important than inflation; and reasons to think that maybe, just maybe, continued innovation could stifle, if not negate the inflation concerns driving market direction right now.
Whichever side you take, hopefully this will help you with your investment decisions in the world we find ourselves in right now.
Chief Investment Officer
Hearts and Minds Investments Limited
Reminder: these are simply my general views and should not be taken as investment advice
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