It may have taken a little more than a decade, but finally a year after the pandemic and the US economy managed to have inflation well above analysts' estimates. The data showed an increase in inflation to 4.2% and followed by chain reactions across the market spectrum. The table below shows in detail the annual monthly change for each of the categories that make up the inflation index.
The table above is very useful in helping us understand if inflation has come to stay or it is temporary due to the current situation and the restart of the economy.
With the outbreak of the pandemic, the Fed, having the very recent experience of the financial crisis and being in an environment of zero interest rates, did not let the circumstances make it inactive. He acted quickly and unfolded a multi-trillion dollar support package. The second and even more important, was that this time the US Treasury Department was at the forefront from the beginning. In addition to the many support measures it took, it did something unique: it gave money directly to the American taxpayers who in several cases were found to receive more than their salaries.
Analyzing the above table further, it is obvious that there is a cyclical increase in inflation, as the largest increase in inflation was observed in the energy and transportation sectors. It is perfectly normal when just 12 months ago the oil was in negative territory and all kinds of transportation stopped due to pandemic restriction measures.
Furthermore, the pandemic caused significant problems in the supply chain with a lot of delays and big shortages, which sharply increased costs. Also, the period of home confinement, combined with the monthly checks from the US Treasury Department, boosted consumer demand. Both of these trends do not seem to be sustainable.
The increase in air fares is due to the explosion of holiday mood after 12 months of restrictions and as a large percentage of Americans have been vaccinated. The sharp rise in prices, due to a sharp rise in demand is something that is not sustainable and in the coming months will return to normal, before the pandemic. The same logic applies to hotel reservations. All of these are conjunctural and unsustainable.
During this period, it seems that there is an increase in inflation because supply and demand are at an extreme level of imbalance which over the months will normalize.
The Fed had been preparing the ground since the beginning of the year when, during a press conference, it was reported that the US Federal Reserve would have no problem letting inflation rise above the target in the short term. Since then, a "game" of pressure from the bond markets has begun with treasuries under intense pressure as investors began to anticipate that rising inflation would lead to a faster completion of the Fed support program. These estimates have not changed despite the insistence of Fed executives that support is not expected to be withdrawn in the near future.
The last time inflation was above 4% was shortly after the onset of the global financial crisis, when the US economy was entering a recession and markets were already beginning to fall sharply. Today, we have something completely different. The US economy has exited a historic recession caused by the pandemic, and a violent restart of the economy combined with support measures has led to a sharp rise in inflation.
Parabolic rise in commodities and inflation
Another reason that makes us wary of high inflation is the parabolic rise in commodity prices. As shown in the chart below, commodities display an outlook that resembles investment mania and this will sooner or later have the consequence of a move to lower levels. If this upward rally of commodities is reversed, inflation will decline. It is indicative that gold remains in an investment drought, something that can not be in line with expectations for high inflation.
Inflation, economy and investment chances
In recent months, waiting for the economy to restart and anticipating rising inflation has led to a sharp drop in bond prices, and there has been a fairly strong rotation in sectors that were expected to benefit from the resumption of economic activity but also from increased inflation. The following graph shows the course of the sectors with the best annual performance. It is no coincidence that these sectors are also the ones that historically record the best returns in periods with inflation higher than 3%.
These sectors are a new source of opportunity as they are expected to play a leading role in the coming period during which on the one hand we will have strong confirmation of US growth with strong macroeconomic data and on the other hand there will be violent movements in indices due to the situation we described above.
The interest rate rise, the rotation towards value sectors and the return to normality with the bonuses starting to decrease led to a violent reversal of some of the most retail trades in the technology sector as well as funds that were directly related to it.
Apart from the many examples of technology companies that are 20% and 30% lower due to rising interest rates and mass liquidations, there is a specific example which shows that mass hysteria for purchases is never a good guide and always has the same ending. The graph of the well-known ARKK ETF is absolutely instructive, with last weeks’ losses being 40%.
It seems that there is a very high probability that the technology sector will continue to be under pressure as on the one hand the profits of the previous months and on the other the violent leverage could lead to even lower levels as companies without income and without a plan for in the future, will return to the ground from the stratosphere.
In addition, over the past few months, several technology companies have made investment moves that have absolutely nothing to do with their core business, resulting in greater correlation with other markets. Typical examples are MicroStrategy and Tesla, where they chose to differentiate themselves in bitcoin (more or less) with the result that their stocks acquire the characteristics of high volatility of the respective market.