Bad moon rising

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   By Guest Blogger Ryan Lewenza

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Bad Moon Rising
I see the bad moon a-rising
I see trouble on the way
I see earthquakes and lightnin’
I see bad times today
– CCR

I’ve always been big into music and one of my favourite bands growing up was CCR or Credence Clearwater Revival for all you young punks. I was thinking of their classic hit, Bad Moon Rising, when I read the recent inflation report out of the US.

Unless you’ve been living under a rock for the last month (or could care less about economics and the financial markets), then you know we got a big negative surprise from the April US inflation report, which has the global financial markets on edge right now. The above lyrics from that song capture the sentiment among some investors and analysts that inflation is primed to skyrocket, potentially derailing the nascent economic recovery and bull market. I’m not so sure.

The monthly Consumer Price Index (CPI) report is generally a ho-hum event and not a major market mover. Not this time!

US CPI rose 0.8% mom and was up 4.2% yoy, which marks the highest reading since 2008/09. This spike in inflation has some worried that all the money printing and government stimulus is/will lead to an inevitable surge of inflation and it could be starting now.

US Headline CPI Jumped to 4.2% in April

Source: Bloomberg, Turner Investments

I definitely see inflation picking up and ‘running hot’ for the next little while, but I’m not buying the high 1970s/80s inflation thesis when US inflation peaked at 15%.

First, inflation is surging in part due to ‘base effects’. CPI is a yoy statistic and this time last year we were dealing with the early fallout from the pandemic and prices were dropping (last April CPI was -0.7% mom). With the current economic recovery, prices are naturally rising and are getting a boost from this yoy base effect.

Second, there are two main causes of inflation – ‘demand-pull’ and ‘cost-push’.

‘Demand-pull’ inflation is what we typically experience when the economy is picking up and consumer demand outstrips supply. This higher demand leads to higher prices for wages, rents, Big Macs, gasoline etc.

In contrast, ‘cost-push’ inflation occurs when there is a shortage of goods or supply, which helps to drive prices quickly higher. I believe we’re seeing more of this ‘cost-push’ inflation at present.

The pandemic has dramatically changed our spending habits as we’re spending less at restaurants, our local barbershop, dentist visits or traveling (i.e., services). Instead we’re buying new fridges for our updated kitchens, outdoor patio furniture for our backyards, or a new bike so we can escape the confines of our home. These are called ‘consumer durables’ and a lot of this Covid-induced buying is contributing to this uptick in inflation. But, as we continue to vaccinate and approach that 70-80% ‘herd immunity’ rate, we should then come out of our dungeons (I mean our homes), and start spending again on those neglected services. Instead of staying in, we’ll be going out to the bars, restaurants and movie theatres and try to get back to ‘normal’. So as we shift from durables back to services this could help to take some steam out of the inflation readings.

Third, to really get inflation going you need wages to move appreciably higher and that is not the case right now. As seen below, US hourly earnings growth has dropped to a crawl and is the lowest level in years. With still lots of unemployment and slack in the labour market, I don’t see wage growth screaming higher over the next few years.

US Wages Are Under Pressure

Source: Bloomberg, Turner Investments

Finally, as I covered in another post on inflation (https://www.greaterfool.ca/2020/09/26/inflations-coming-in-time/), I see a number or major deflationary forces like globalization, aging demographics, and technology that should help to keep inflation in check over the long-term.

It’s May 24 weekend. Go and crack a couple of cold ones and celebrate the start of summer. Better days are coming with the vaccine rollout ramping up. Finally! I don’t think you have to worry too much about inflation, so go and crank up some CCR and have a good (but responsible) weekend.

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.