Weekly Market Update: Operations Managers are the new economists

Mon 15 Nov 2021

Market Update

Equities in most major markets posted minor gains last week with global stocks up +0.3% in Sterling terms, as inflation concerns seem to have stemmed a previously strong investor sentiment. US stocks were up +0.2% as multi-year high inflation data offset positive news on employment data. EU stocks were up +0.2%, despite Covid-19 cases surging in most countries in the region. UK stocks were up +0.7% while EM equities rose by +2.2%, driven by China’s announcement that it would propose easing measures to aid indebted real estate firms. The US 10Y Treasury yield was up 11.0bps finishing the week at 1.561%, while the UK 10Y yield was up 6.9bps reaching 0.914%. In US Dollar terms gold posted solid gains for the second week in a row, up +3.1%, while oil was down -0.1% to $80.4 per barrel.

CIO Analysis

Inflation concerns dominate the discussion after last week’s surprise 6.2% yearly rise of goods in the United States. European numbers also picked up, with Germany, the manufacturing heartland of Europe and historically an inflation-phobe, registering the highest inflation numbers in more than two decades.

Numbers themselves are useless, of course, if they are not broken down. While year-on-year US inflation has hit 6.2%, since October 2019, prices in the US have risen 3.6% per annum. This of course is still close to twice the Fed’s target of 2%. Excluding food and energy, the bi-annual rate is closer to 3%.  Around a tenth of the weight is due to sharp rises in the costs of new cars and trucks, which have risen more than 12% per annum. Deduct just this one category, plus energy and food, and average-two year inflation would be closer to a much more acceptable 1.9%-2%.

This 6.2% headline number is highly focused on energy and car prices. And while these are very real costs for consumers there is precious little central banks can do about them. With supply chains stretched to the point of breaking and possibly beyond, demand for manufacturing goods has been erratic and based on availability. Scarcity only drives up demand itself (“I may need one item X now, but if there are only a few available, I might as well order two to cover future needs”). Just-in-time inventories have given way to a good-old-fashioned stocking-restocking cycle and without the availability of warehouses, congested ports have taken their place, causing even more congestion. This has caused energy and transportation costs to soar. The supply chain problem is so sprawling that it would take a centralised global approach to address. Unfortunately, the Covid-19 crisis has only exacerbated geopolitical problems, placing a coordinated solution realistically beyond reach.

Adding to lockdown-related dysfunctions, China, the world’s top trading partner, is going through its own political and economic transition. Supply chains were already stretched and have become hyper-sensitive to even the smallest disruptions (see Suez Canal issues). China adding further pressure could well break the proverbial camel’s back.

The length of this inflationary bout will be very closely correlated to developments in China. What it will not be correlated to is the Fed’s interest rate cycle. The US central bank has signalled that it does not intend to fight this price spike. If it did, interest rates would already be above 5%. Whether transitional or not, the Fed doesn’t  have the tools to deal with supply inflation in a globalised economy. Instead, it is tapering asset purchases to fight asset price inflation, which is taking place in the financial economy. Reports last week suggest that Joe Biden is thinking of replacing dove Jay Powell with uber-dove Lael Brainard.

As inflation grips economies, it has become apparent that to assess this particular incident, we must look beyond interest rates, money velocity and recent history. For markets to understand what will happen with the financial economy and risk assets, they still need to focus on central bankers. To understand what the future brings on inflation and growth, however, instead of economists, portfolio managers would be better served to turn their attention to operations management and Xi Jinping. 

–David Baker, CIO