Markets remained mostly content as we headed into the Thanksgiving Day holiday. U.S. equity indexes are close to their all-time highs and 10-year U.S. Treasury note yields, despite the hot inflation readings of late, are around 1.68%, about the same as in the spring. The major financial news this week was the re-nomination of Jerome Powell for another term as Chair of the Federal Reserve. Chair Powell is seen as somewhat more hawkish (likely to raise rates) than his main competitor for the nomination, Lael Brainard (Brainard was tapped for Vice Chair). Powell is likely to keep the Fed on course to both reduce its bond-buying program as well as to prepare investors and the markets for eventual interest rate increases beginning, perhaps, in the second half of 2022. With the news of Powell’s renomination, the broad equity markets held firm, interest rates nudged higher and technology stocks, which enjoy low interest rates, tumbled.
Supply Chain Problems Persist
On a recent trip to Huntington Beach to take my son surfing, I counted, from my vantage point on the sand, 22 heavily laden container ships bobbing at anchor off the Port of Long Beach. There are many more just out of sight. The supply chain crunch is serious and will not be resolved for many months. It is impacting inventory levels across many industries, including food, apparel, autos, and electronics. In the meantime, many companies will struggle to make their fourth quarter financial projections not because of a demand shortfall, but because they cannot get their products to market. Also exacerbating the crisis here in the U.S. are worker shortages due to accelerated retirements and job changes during the pandemic. If there is eventually a silver lining in the supply chain crunch of 2021, it may be this: companies’ inventory-to-sales ratios are now the lowest they have been in more than twenty years, potentially presaging a surge of inventory restocking in 2022 and 2023 as supply chains begin to unkink.
The Fed Takes Center Stage
Now that President Biden has nominated Jerome Powell for another term as Chair of the Federal Reserve, investors are trying to project how equity and bond prices will react as the Fed begins to tighten interest rate policy. While the Fed is sure to do its best to telegraph its planned efforts clearly, it is likely that Fed policy will turn into a headwind for asset prices after having been a strong tailwind for the last decade. An unaccommodating Fed will be a major new risk factor for investors to consider.
We Need Tighter Money
Our view is that exceptionally accommodative monetary policy has created distortions in many markets (e.g. bonds, stocks (both real and meme), and real estate) and that the Fed should move steadily, but openly, toward reestablishing a more normal interest rate policy. Markets may not like monetary tightening in the short term, but we think our economy (and our citizens) will ultimately benefit from capital markets that are more focused on fundamentals and are less reliant on an excess of cheap money sloshing around. But the Fed is in a sticky position. Loose monetary policy, along with the demand shock of a reopening economy, has poured gasoline on the inflation fire, and the Fed could be behind the curve in fighting it. Next year, however, two things will likely happen that will help to put a damper on inflation.
First, there will probably be some progress on the supply chain problems, leading to higher in-stock levels and moderating prices.
Second, the stimulus the Federal government injected into the economy during the early days of the pandemic will begin to fade.
These two factors should coalesce and help the Fed to keep inflation under control. Investors, however, seem to be getting antsy that the Fed is being too complacent. We’ll see what the inflation numbers look like over the next few months . . .
Companies Seeing Strong Demand, Thin Supplies
Companies, broadly speaking, are seeing plenty of demand for their products and services. The problem remains supply. If supply constraints should worsen or linger too much longer, demand could begin to suffer as well. Two factors could cause consumers to have less discretionary income to spend in 2022. First, prices for almost everything are going up. Fuel, rent, food—you name it. With a greater percentage of household income going to satisfy these necessities of life, there will be less available for discretionary spending such as travel, eating out and entertainment. Second, Federal unemployment stimulus will be drying up somewhat as we get into 2022. With any luck in the new year, however, supply chains will ease, prices will moderate, the Fed will gradually tighten and we will enjoy moderate economic growth.
Please contact us if there is anything you would like to discuss about your investments or the markets.
