The stock market has provided yet another strong year of returns so far in 2021. But look deeper and you will see numerous headwinds that could cause trouble in the coming years. There is so much that can be written about each of the items below (not counting what I’m not including for sake of brevity and trying to not put you to sleep), I could do a blog post on each one. But to at least get you thinking about the issues that I consider each and every day, here is a list of concerns swirling around in my head.
Inflation is roaring back and the Fed has finally stopped using the word “transitory”. Higher prices can be found all over the place and all along the supply chain from the manufacturers to the retailers. You see it at the grocery store and at the gas station. Inflation is an interesting beast. But if prices rise and then stop rising (e.g. transitory), inflation settling back to a sub-2% ongoing rate, we are still paying higher prices today than a year ago. But the expected rise in the future price will not be 6.2%. This wouldn’t be horrible, but we are still paying higher prices. The problem is if inflation stays high and prices keep rising faster than they have in the past 30+ years. This has a devasting impact on the cost of living and economies in general. It has been almost 40 years since we last saw a period of high inflation and most people don’t remember what it is like. Scary thought.
Supply bottlenecks are slowing getting addressed but even as I write this, Long Beach and Los Angeles ports are struggling to move containers because there is nowhere to put them and there aren’t enough trucks to move them all. Check out San Francisco Bay next time you drive by the shore. See all those ships sitting in the middle, fully loaded? They’ll still be there in a few days.
Semiconductor chip shortages are up and down the supply chain and affecting multiple industries. New vehicles are seeing strong price increases and used cars are increasing in value. The problem is to increase the supply of chips, manufacturers need to build new chip plants but that takes years and billions of dollars. And they don’t want to build new plants to make the cheap chips that are in short supply today because by the time a new plant is ready, there may not be a supply shortage anymore for those chips. The new plants getting announced by TSMC and Intel are all plants that will make high end, high margin chips. We could be looking at a chip shortage that lasts multiple years into the future, keeping the pressure on inflation.
Wages are rising all over the place. This is great news! According to the Employment Cost Index from The Conference Board, wages have risen 4.3% in the six month period ending June 2021 and are still rising. The problem is that inflation over that period is 6.2%, meaning workers are actually seeing real wages decline. Once all those savings built up over the pandemic are spent, disposable income could start dropping.
Automation is a great solution for companies to keep a lid on costs. If wages keep rising fast, those robots become a lot more attractive as an investment. If more automation occurs, we will see reduced demand for entry level jobs which could lead to even higher income inequality. Bad news for lesser educated people and those just starting out. To see this in action, go to a McDonalds drive-thru and watch through the window. The whole restaurant runs with maybe 3 people when it used to have 6, 7 or 8. Automation is everywhere. How will increasing income inequality impact society and our hyper-partisan country and what will the government do to respond?
Climate change is one focus of today’s Federal government. There is growing societal pressure to cut emissions and push renewables in all aspects of the economy. Companies are making pledges to be carbon neutral or announcing new investments in electric this or electric that. Pressure is building on investors and banks to stop funding oil, gas and coal projects in the U.S.A. and abroad. Yet all those electric vehicles need electricity (at night mind you) and renewables don’t always generate electricity 24/7. We need diversified electric production, including natural gas, nuclear and yes, even coal. We need multiple power plants that can be turned on at a moment’s notice and that generate massive amounts of power. Shortages we saw in California in the summer of 2021 during the heat wave showed what happens when renewables can’t generate enough electricity or keep up with demand when the sun goes down. Our elected officials are not telling the whole story. It will take new innovations and continued use of fossil fuels for many, many years before we are ready to dial back the use of them. Why are we cutting investments in oil and gas? Electricity demand is soaring and will likely grow even faster in coming years. How will renewables alone handle all the growth and replace fossil fuel sources to meet the goals our officials have set? Scary thought to think that reduced oil and gas production in the U.S.A. means we will once again become dependent on foreign oil from places like Saudi Arabia, Russia and other autocratic countries.
Interest rates… I had to get here at some point. Look at the headline inflation number of 6.2%. Even if it drops to 3% and hovers there for a few years, we are sitting at 10-year yields at roughly 1.5%. That means for every year you hold a government bond, you are losing money when you factor in inflation. This has been going on for years. How long will this continue? What will happen to interest rates, both short and long term? It is inevitable that the Fed raises the Fed Funds rate up from 0%. But how fast do they do it and when do they pause? And what happens to the 5-year and 10-year yields while they do it? What will this do to the stock market? Don’t believe people when they say that “oh, low interest rates are the reason the stock market is on a tear”. A share of stock is simply the right to the cash flow from that company in the future. Low rates today are driving investors out on the risk curve into riskier assets, driving up prices and driving the market higher. High returns today simply mean that investors shouldexpect lower returns tomorrow. What happens when investors decide they have too much risk? Hold on tight…
Wow – that sure does seem like a lot of bad news. But if you have your health, you have a job, you have a roof over your head and are surrounded by friends and family, life is pretty good and that won’t change regardless what happens. All this leads me back to the one constant you hear from me all the time. Let’s make a plan that helps you achieve your goals and we stick to it. The best you can do is watch your spending, save what you can and not let emotion get the best of you. We can ride through the storm together and watch the sunset that will be on the other side.
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