Inflation is unfortunately showing its ugly head, but is it simply growth driven price increases? I believe it has been one of the market’s most underappreciated risk factors. In my opinion, the current increase in inflation is primarily propelled by the restart of our economy, pent up demand, and supply chain crisis. Producers have battled to meet increasing demand but ineffective ports have created shipping cost increases, not a good thing. We have not seen a major supply shock like this since the oil embargo created by producers in the 1970’s. (for those who remember the mile long lines to get gas on the day of the week you were assigned). Still, I don’t think the economy is headed to stagnation, as it did back then. In fact, it is plausible that things today are opposite of the 70’s. Growth is dramatically increasing, not stagnating, which is a natural cause in increasing oil prices and commodities.
Today’s outlook is different due to the current uptick in inflation, largely the result of the economy’s restart, not increasing energy prices. In addition, the supply chain has not come back online in a timely manner, resulting in bottlenecks and price increases. Second, growth is still having a clear path to run, with global activity still well below its long-run potential. Eventually supply will catch up to demand, instead of demand needing to ease to meet supply, which was the case in the 1970s. Third, it’s the resurgent economy that is increasing demand for oil and driving up prices. Of course, oil production in the United States was reduced shortly after President Joe Biden took office. Demand is certainly a driver of price, but so is supply. Perhaps we have more than simply growth driven price increases.
We expect the restart demands to continue into deep 2022 before showing signs of subsiding as short-term supply and demand disparities improve. In addition to the restart there are a few factors that could add to this persistence: merging in the resources industry, capital restraint by producers, neglect in improving production capacity, and shifting to more sustainable energy sources.
There is a risk that the markets and central banks misread the current shocks, which could lead to fast paced inflation expectations or premature monetary tightening. We believe central banks will largely disregard the restart price pressures – and avert a premature tightening that deters growth but does nothing to deal with the supply issues. We expect this to play out inversely around the globe and could see some central banks take a more combative approach than others.
From our perspective, the long- and short-term demand for calls and puts, presents a strong message of traders betting on a short-term positive move in the market. On the other hand, they willing to pay a premium to hedge longer term risk. Puts on Leaps, (Leaps are options with maturities exceeding 9 months) are selling at a premium relative to comparable calls. Market volatility has kept short term call premiums attractive which leads us to shorter term, higher strike price calls.
The bottom line: Inflationary forces are constant today. We believe price pressures return to normal and imagine central banks with credible policy frameworks will see past these transitory environments. Our investments continue to lean towards equities on a strategic basis. If you want to learn more or need help with your investment program, we invite you call or email. Let’s talk!
*Chart and some content provided by Blackrock. Global Weekly Commentary – Insights | BlackRock