The economic recovery continues, as the recipe of vaccines, the reopening, and record stimulus all have combined to produce what should be the best years for growth ever. Although some economic indicators could be peaking or about to peak, the stage is set for this cycle of growth to continue for many years, which may surprise some investors. We discuss why inflation might be in the headlines, but still shouldn’t be a major worry for investors.
THIS ECONOMIC CYCLE IS QUITE YOUNG
LET’S TALK ABOUT INFLATION
Here are some reasons we expect inflation to be transitory:
- The root cause. The reopening is happening, supply chain issues are making it harder to get goods, some jobs are hard to fill, and massive stimulus has created high savings levels, all of which have caused
price pressures to build. But once the reopening has taken place and these bottlenecks have cleared, we would expect inflation readings to come back down. The Fed agrees, having said for months that any
higher inflation numbers will be transitory, which means things should go back to normal once we get past the shock of reopening.
- Easy comparisons. In the midst of the pandemic last spring, CPI was negative three consecutive months in a row and April saw one of the largest drops ever. Now with the economy improving, comparisons from those dark days are extremely easy, likely distorting the yearly inflation numbers.
- Recovery plays accounted for most of the jump. Used car and truck prices jumped a record 10%, lodging climbed 7.6%, airfare 10.2%, car rentals 16.2%, and sporting events 10.1%. All of these are heavily impacted by the reopening process and accounted for nearly all of the jump. As these prices get back to normal, we expect inflation to calm down. How many more cars can people buy? And, of course sporting events were cheaper a year ago when no one was going to them. Meanwhile, other major components of CPI, like rents (0.2%), showed much more modest increases.
- Bigger forces still in play. Yes, near-term inflation has spiked, but in the longer-term a 1970s-style scare is extremely unlikely. Technology, globalization, the Amazon effect, increased productivity and efficiency, automation, and high debt (which puts downward pressure on inflation) are among the major structural forces that have put a lid on inflation the past decade plus—and will likely continue to do so.
The economy continues to strengthen and, so far, this year is off to a better start than even the most bullish economist could have expected. There are always risks though, including COVID-19 spread outside the U.S., deficit spending, geopolitics, inflation, tax increases, and a potential policy mistake. Not to mention after a record 89% rally for the S&P 500, a well-deserved break or consolidation during a historically weak time seasonally would be perfectly normal. But, amid a backdrop of an improving economy, massive levels of fiscal and monetary stimulus, and rising vaccination rates, we don’t expect any pullbacks to last very long, and we’d use any that appear as a buying opportunity. We upgraded our forecast for the global economy and U.S. corporate earnings in April, and last week upgraded our 2021 year-end S&P 500 fair-value target range to 4,400-4,450. We continue to recommend an overweight to equities and underweight to fixed-income position relative to investors’ targets, as appropriate.
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