During the last 90 days, we all heard it “ad nauseam,” inflation has arrived and is here to stay. The narrative has been relentless and effective. It progressively eroded investor confidence until the stock market entered a “twilight zone,” a kind of parallel universe totally divorced from the massive economic recovery underway.
As a way of an example; so far in 2021, earning releases beating expectations have barely moved up the underlying stocks, while earnings misses have caused brutal drops in the reporting stocks prices. An irrational market looking for any reason to go down.
Panic selling and liquidations have been followed by widespread capitulations, the telltale of a major market correction. Countless stocks and mostly all of the cryptocurrencies have been massively oversold, losing between 30 to 50% of their market caps. The big losers appear to be retail investors, while big investors -the smart money- seem to have been “buying the dips.” In just a few weeks, once again, a massive transfer of wealth from main street to the country’s 1% has taken place.
But, has all of this mayhem taken place predicated on a lie?
Well, while financial analysts from the biggest Wall Street financial players have touted inflation to main street, they have been quietly sharing a totally different point of view with their large clients.
A good example of this is a Goldman Sachs report dated, May 21, 2021: “CRYPTO: A NEW ASSET CLASS?” On-Page 2, the headline is, “…We now expect core PCE inflation to peak at 2.8% in May and fall to 2.25% by year-end 2021 after the strong April CPI print…” further down the GS report adds, “Pandemic Distortions to core inflation should peak soon.”
It is true that a pandemic-induced economic recession has taken place. Consumer demand collapsed, causing supply chains to contract and factories to cut production or even go idle. Therefore, the restart of the economy is and will be filled with enormous supply-chain constraints and price pressures until unmet demand subsides.
It is easy to argue though that in a world of highly efficient supply-chains, extremely competitive and mature markets, the pre-pandemic demand and supply numbers will all fall back into place as the economy recovers.
To illustrate this, let’s take a look at the car manufacturing industry. According to Statista, the worldwide automobile production per year was: 90, 91, 95, 97, 97, 92, and 78 million vehicles during the years 2014, 2015, 2016, 2017, 2018, 2019, and 2020, respectively. In 2021, the production level is projected to return back to 90+ million vehicles per year. Meaning that, in a mature market like the automobile industry -where we find pretty consistent, solid numbers year after year- growth can only be based on the pre-pandemic historical numbers.
Besides the continuity of historical growth rates; the number of people buying automobiles around the world every year, the potential automobile global demand in normal economic conditions, and the production capacity of the automobile manufacturing plants, have not changed due to the pandemic. Thus, as we emerge from the economic recession we’ve been in, automobile sales are not going to be 100million+ per year but a progression of the 90million+ in yearly worldwide automobile sales we’ve experienced since 2014.
A lot of fuzz has been made about by Wall Street analysts and economists about the jump on the Consumer Price Index (CPI), as well as, the sharp increases in commodities prices; yet, the vast majority of our CPI is not commodity, but service driven. Further, manufacturing as a whole is only 11.39% of our GDP. The US is a services-based economy.
Besides, The Personal Consumer Expenditure (PCE) measure -not the CPI- is the Fed’s favored metric. At present, the PCE inflation metric for the last 12 months is 3.6% and 3.1% for core inflation (excluding food and energy). The PCE inflation forecast for 2021 is 2.9% and 2.3% for core inflation. This is pretty much in line with the Goldman Sachs report previously mentioned.
Normally, the CPI index runs 30 basis points higher than the PCE, but for 2021 Goldman Sachs analysts Jan Hatzius and Spencer Hill believe that the gap between both indexes could be as high as 1% point. PCE seems to be the better metric in periods of economic instability. For example, it tracks price increases that are not likely to be repeated once the pandemic is over, like energy, airfares, restaurant meals, hotels, car rentals, purchases of used motor vehicles, health care services, etc.
Is there short-term inflation out there? Absolutely. But, except for specific products like semiconductors or the construction industry that require a much longer manufacturing ramp-up period, most supply-chains will be normalized during the course of the year; This seems to be supported by the recent drop in commodity prices. Aluminum, steel, copper, lumber, and corn fell 12%, on average, from May peaks. Lumber in particular has dropped more than 30%. Wholesale Inventories seem to be falling in line with sales ratios as well. As supply and demand fall in line, the threat of inflation will go away.
Unfortunately, when the dust settles, the carnage for main street small investors duped by the hyperinflation ruse will be enormous, while Wall Street will come out with a precious bounty of cheaply bought oversold stocks and cryptocurrencies, all of them obtained at main street’s expense.