Dec 03, 2021
WHAT’S HAPPENING TO INFLATION?
News about inflation has been in the headlines lately – for example, consumer prices in the biggest economy, US, “post(ing) their biggest annual gain in 31 years, driven by surges in the cost of gasoline and other goods1.” CPI had jumped to 6.2% year-on-year which is the biggest increase since 1990. Even Singapore’s overall inflation had risen to 3.2% in October, the highest since March 20132.
In fact, the projections for inflation have been increasing every few months.
Wasn’t it supposed to be transitory?
Earlier assertions about inflation (especially by Fed) were that it would be transitory.
We believe that was the first wave of inflation.
The first wave was brought on by the supply chain disruption due to COVID-19 restrictions, unavailability of vaccines in certain areas, and pent-up demand. “Supply chain bottlenecks — congestion and blockages in the production system — have affected a variety of sectors, services and goods ranging from shortages of electronics and autos (with problems exacerbated by the well-known semiconductor chip shortage) to difficulties in the supplies of meat, medicines and household products3.”
This was due to bottlenecks in almost every link in the chain – raw materials, labour, shipping, ports, containers, all modes of transport, and warehouses, “with disruption in one part of the chain having a ripple-down effect on all parts of the chain, from manufacturers to suppliers and distributors with disruptions ultimately affecting consumers and economic growth.”
Currently, how fast an economy re-opens to facilitate economy recovery and growth is dependent on the population’s percentage of vaccinations. And the countries that have larger proportion of their population vaccinated are the developed countries. However, the developing countries are also catching up on their vaccination rates, and thus the re-opening of their economies and the “recovery” of supply chains are probably just a matter of time.
Another contributor to the “short-term” inflation was the lack of investment in the areas such as new oil supplies. This is due to the shift in focus to cleaner fuels1. This has also driven price volatility currently.
What’s contributing to the persistent inflation?
Bringing on the 2nd wave of inflation, however, are stickier components like labour and housing.
Let’s explore what might be making them more persistent.
Earlier in April, when the number of workers in US who quit their jobs broke an all-time record, economists started calling it the “Great Resignation4”. But the record kept getting broken, with July’s, August’s and September’s all setting new records.
Aren’t most people concerned about keeping their jobs during a pandemic?
If we look closer at what’s happening, we will find that it isn’t such a mystery.
Firstly, the baby boomers who were born between 1946 and 1964 after the world war years contributed to the largest number of births.
This also means that as they retire, their withdrawal from the labour market would be felt as keenly as they had contributed to the economic boom in the 1960s.
In the US, the earliest age to start claiming retirement benefits is 62.
And it was in 2008 when the first baby boomers reached 62 that coincided with the steeper drops in labour participation rate before COVID-19 (circled purple).
Perhaps the “Great Resignation” might not be such an anomaly after all as the participation rate had held up between 2015 and 2020 when it should have tapered off.
Secondly, with the pandemic, as many re-evaluated their career and lifestyle choices, some could have chosen to take an early retirement. Between the labour participation rate of 63.4% and 61.6%, the absolute number of workers missing is 6 million.
And what’s causing a wage increase is because even if everyone who is looking for a job finds one, there are still 2.4 million openings.
Thirdly, the infrastructure bill that President Joe Biden just signed into law which will most probably create more jobs will also push the wages up with even more openings running after an insufficient work force.
What about housing?
“Housing is a big portion of expenditure and hence makes up about a third the CPI index. Yet there appears to be a disconnect between the inflation data and the real world on the cost of housing5.” What the data suggested was while rental costs are rising 10% to 20% according to major indices, the CPI index for shelter has risen just 2.8% year-on-year as of August 2021.
This is probably because home owners who filled up their survey (for shelter) with regard to their home equity had less updated “data” or experience compared to renters. This also probably means that rising housing costs need more time to fully appear in CPI figures, and implying that the the current inflation numbers were understated.
Labour and housing costs, unfortunately, as explained above, aren’t as transient. This probably means that we’d have to brace ourselves for higher prices, at least for quite a while.
What does this mean for asset prices?
As higher and higher inflation rears its ugly head, Fed had announced that they will deploy the next tool in their arsenal, which is raising interest rates.
“Interest rates are to asset prices what gravity is to the apple. When there are low interest rates, there is a very low gravitational pull on asset prices,” said Warren Buffett; hence when interest rates are adjusted upwards, they will pull on the asset prices, keeping it from being flyaway.
Our portfolio allocation
Asset prices have been hitting new highs and on an uptrend for more than 10 years, excluding the snag for 2 months last year. This has perhaps made many of us quite complacent about investing as equities have made their due returns without much heart ache.
With our current view of inflation and what rising interest rates could do, our strategic or default allocation of our assets would be 50% in Capital Growth and 50% in Capital Preservation tools, such as Gold, Bonds and Cash.
If you think you might have a portfolio that might not be properly diversified or not sure of which asset classes to select, do speak to your Unicorn Consultant if you would like know more or have further queries.
Note: We had increased the frequency of our communication with you during turbulent times. We will continue to communicate monthly with you during usual times.
Sources:
1. Reuters
2. The Straits Times
3. CNBC
4. The Atlantic
5. Forbes
6. Wall Street Journal
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