2021 Q2 Commentary
The Great Reopening
After spending nearly a year at home during the pandemic, most Americans were longing for a return to normalcy. Church on Sunday, family dinners, shopping excursions, or dinner with friends at a local restaurant. Now that the number of coronavirus cases in the U.S. has receded substantially, Americans are doing just that and in force. The pent-up demand to travel, eat out, and acquire all manner of consumer goods has been incredible. Unfortunately, this robust demand hit at a time when supply chains were largely depleted resulting in the scarcity of many products and long lead times to take delivery. Some automakers are especially struggling with production bottlenecks as they cannot source enough microchips to power the electronics in their cars and trucks. The burst of economic activity could be seen in the first quarter Gross Domestic Product (GDP) which increased at a 6.4% rate, the second fastest pace for growth since the second quarter of 2003. Consumers, who account for roughly 70% of the economy, accelerated spending by 10.7% in the quarter, compared with a 2.3% increase in the previous period. Economists surveyed by the Wall Street Journal expect the economy to grow at an 8% rate in the second quarter, leaving it poised for its best year since the early 1980s.
The U.S. economy’s rebound from the pandemic is driving the biggest surge of inflation in nearly 13 years, with consumer prices rising by 5% from a year ago. Not surprisingly, consumers are seeing higher prices for big-ticket items such as vehicles, where prices for used cars and trucks leapt 7.3% from the previous month, driving one-third of the rise in the overall Consumer Price Index (CPI). We are also seeing upward wage pressure as employers struggle to hire qualified candidates. The pandemic caused a huge drop in the labor force participation rate, equating to roughly 3 million people leaving the workforce. Much of this drop resulted from pandemic related problems like fear of the disease, difficulty in getting child-care, and generous unemployment benefits. The Federal Reserve (the Fed) believes this inflationary surge is transitory and will likely ease as supply chains catch-up, the rate of economic stimulus slows, and more people reenter the workforce.
Where To From Here?
The pandemic caused a sharp and sudden downturn in the U.S. economy. The U.S. Government and the Fed responded to this economic shock with unprecedented speed and force. On the fiscal side, Congress allocated $5.3 trillion toward enhanced unemployment benefits along with a variety of other spending programs that helped push the federal budget deficit to $1.7 trillion in the first half of fiscal 2021 and has sent the national debt soaring to $28.1 trillion. Congress is also considering a trillion-dollar infrastructure plan from the White House. The Fed has also come through, cutting its benchmark short-term borrowing rate to near zero and buying nearly $4 trillion worth of bonds, ballooning its balance sheet to nearly $8 trillion. It is our expectation that the rate of additional fiscal stimulus will slow over the next year. In addition, the Fed has already communicated they will likely begin to taper their asset purchases by the Spring of 2022, if not before. This combined tightening of fiscal and monetary conditions coupled with supply chains catching up to demand may result in an easing of inflationary pressures later this year. This is consistent with the signal being sent by the U.S. Treasury market. After 10- year Treasury yields rose to 1.7% on the back of inflation concerns, yields have now fallen substantially, sitting close to 1.3% in early July. Falling interest rates are not typically a sign of runaway inflation or accelerating economic growth. If anything, it may be signaling a slowdown in economic growth in the next 12 months. We shall see.
We remain concerned about the rich valuations we observe in many asset classes and the unbridled risk seeking behavior of some “investors” looking to punch their lottery ticket. As such, our focus remains on owning a diversified portfolio comprised of strong durable businesses at reasonable prices while avoiding speculative excesses that can easily lead to a permanent impairment of capital. Times change but quality endures.
As always, we remain committed to helping you achieve your financial goals. We are grateful for the trust you place in us.