Highlights:
· The Omicron strain threatens to reverse much of the economic goodwill that was generated in the second half of 2021.
· It is unlikely that inflation will subside materially until Covid-19 is under control, workers can safely return to work uninterrupted by Covid-related illness, and supply chains return to normal.
· The world remains as uncertain as ever, which is why we continue to espouse a long-term, planning-driven investment policy.
Commentary:
“The pandemic has been calling the shots for the economy and for inflation. And if we want to get inflation down, I think continuing to make progress against the pandemic is the most important thing we can do. I think it’s important to realize that the cause of this inflation is the pandemic.”
-Treasury Secretary Janet Yellen
To be (vaccinated) or not to be (vaccinated)? This is the question that hung over the global economy for much of 2021, and continues to do so as we enter 2022. For as much progress as was made on the vaccine front, more people died of COVID-19 in 2021 than in 2020, both in the U.S. and worldwide. The economy has seemed to ebb and flow with rising and falling infections, and as of the writing of this commentary the Omicron strain threatens to reverse much of the economic goodwill that many countries and none more so than America, generated in the second half of 2021.
Echoing Treasury Secretary Yellen’s sentiment, Fed Chairman Jerome Powell wrote in his recent testimony that “greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply chain disruptions.” Powell later went on to call high inflation a “severe threat” to a full economic recovery and indicated that the Fed was preparing to raise interest rates because the economy no longer needed emergency support. These comments reflect an abrupt policy shift from Powell’s position from most of last year in which he repeatedly stated that he believed inflation was transitory due to supply-chain bottlenecks associated with reopening the economy.
Preliminary data shows that the Omicron variant spreads quicker and evades vaccine defenses more readily than other strains, but causes less severe symptoms. If this holds true it could lead to the long sought after herd immunity from this virus. Even with herd immunity, it is starting to look increasingly more likely that this disease is in the process of transitioning from a temporary pandemic to an endemic with no end date in sight. This would result in the virus being more engrained in daily life than it already is for many people, and the level of disruption a function of how much risk and Covid-19 deaths disease officials, governments, businesses and individuals will tolerate.
Just recently, the U.S. Centers for Disease Control and Prevention reduced the recommended isolation period for people infected with Covid-19 to five days from 10. A new generation of Covid-19 treatments from Pfizer and Merck could also be on the way soon. These treatments have the potential to not only reduce serious illness, but also to reduce fears and help society move back to normalcy. According to historians, pandemics typically have two types of endings: the medical, which occurs when the incidence and death rates plummet, and the social, when the epidemic of fear about the disease wanes.
All the same, a pandemic is not a financial crisis. Despite all the death, illness and inconveniences that Covid-19 has caused, it has not damaged financial markets or household balance sheets to the same degree as the Great Recession did from 2007 thru 2009. The pandemic did cause a sharp, yet brief recession. However, we have begun to see signs of economic recovery. Today the unemployment rate has fallen below 4%. Single-family home values (the largest single asset for most families) have continued to rise. These milestones were achieved in part by the federal government pumping trillions of dollars into the economy across two administrations, much of it in the form of checks sent directly to people. This has resulted in a cash glut that has led to new economic problems including labor shortages, rising inflation, and clogged supply-chains. These issues have been exasperated by a massive shift in consumption towards goods and away from services.
Consumers in other countries have pent-up desires to spend as well. After delaying purchases for most of 2020 and 2021, foreign governments have enacted large pandemic stimulus programs to support these spending habits. Japan became the latest country to approve a stimulus program to jolt its struggling economy in the form of a $490 billion package that includes cash payments to most families and some smaller companies. However, stimulus packages in other countries have generally trailed the U.S. in both scope and rollout speed. This has created a scenario, at least temporarily, in which U.S. consumers generally have more purchasing power than consumers elsewhere do. This strong U.S. demand tends to be the starting point for global supply chain bottlenecks, which then creates a domino effect and causes issues in other countries due to the interconnected global economy.
There is no quick solution for the current spike in inflation and supply chain bottlenecks. Inflation is unlikely to materially recede until the current cash glut has run its course through the economy. Most big government stimulus programs have already ended and the Fed has signaled it will begin to increase interest rates and taper its bond-buying program. Investors generally took this news in stride, likely because it was a reasonable response to the inflationary economic boom and wage inflation due to workers quitting jobs at record rates. Central banks will now be challenged to maintain a delicate balance between tempering inflation expectations while simultaneously fostering economic growth. The Fed spooked investors when minutes from its most recent meeting showed that surging inflation may force them to raise interest rates “sooner and at a faster pace.” Elsewhere, consumer prices in the Eurozone increased at a record pace in 2021 due to rising food prices. This inflation data challenges the European Central Bank’s message to households and businesses that inflation is likely to subside towards its target level by the end of 2022.
Meanwhile, private companies and government officials are already taking steps to expand the supply chain, such as President Biden moving to keep open the Port of Los Angeles 24 hours a day. Measures like this will help modestly, but the best way to truly fix today’s supply chain issues is getting vaccines in the arms of people across the globe. Until that happens, many factories will likely continue to have trouble keeping up with demand because workers will continue getting sick. According to World Health Organization chief Dr. Tedros Adhanom Ghebreyesu, “narrow nationalism and vaccine hoarding by some countries have undermined equity and created the ideal conditions for the emergence of the Omicron variant, and the longer inequity continues, the higher the risks of the virus evolving in ways we can’t prevent or predict. If we end inequity, we end the pandemic.”
Likewise, capital investment spending by business around the world will likely remain stalled so long as supply-chain disruptions persist and uncertainty remains over the durability of the current economic expansion. This despite the fact that shortages from goods have led to a sharp rise in consumer prices that would normally be a strong catalyst for capital expenditure spending.
We will conclude with a quote from senior economics consultant Neil Irwin of The New York Times, referenced by Howard Marks of Oaktree Capital in one of his recent memos, which we believe summarizes the complexity of our current economic situation: “The world economy is an infinitely complicated web of interconnections. We each have a series of direct economic interrelationships we can see: the stores we buy from, the employer that pays our salary, the bank that gives us a home loan. But once you get two or three levels out, it’s really impossible to know with any confidence how those connections work. In the years ahead we will learn what happens when the web is torn apart [by the pandemic and resultant lock-down], when millions of those links are destroyed all at once. And it opens the possibility of a global economy completely different from the one that has prevailed in recent decades.”
As usual, we refrain from making prognostications when it comes to the economy and financial markets. We acknowledge the complexities of the global economy and inherent uncertainty and volatility of the global equity markets. This is why we remain committed to a long-term investment policy based on cash flow-driven financial projections, diversification, time (and not timing), and an emphasis on financial, tax, and estate planning.
Urban Financial Advisory Corporation – January 2022