In the November issue of our monthly flagship publication, we feature:

  • On the Record by Chief Investment Officer Tony Roth, where he likens investing to driving, with visibility as to our destination nine to twelve months from now, but not necessarily clarity on how we’ll get there. The near-term fogginess is linked to the uncertainty around the answers to these three important questions: Where are the workers? When will supply chain traffic jams clear? How high will U.S. inflation go before peaking?
  • In Focus with Steve Norcini and Jessica Blitz where they discuss the boom in cybercrime incidents and the billions lost as a result in “The Engagement Lever: Pull to activate risk mitigation.” This runs counter to the risk mitigation work done by some managers in the environmental, social, and governance (ESG) space. Learn more about what companies are doing right—and what Wilmington Trust does to help guard against those that are becoming complacent in cybersecurity risk management.
  • Investment positioning and equities asset class overview.

I’m (thankfully) finding myself on the road much more these days, visiting clients, colleagues, and family, and am struck by how similar investing is to being behind the wheel of a car. Like driving, investing requires a careful consideration of many visible and invisible risks, looking both ahead and behind us when interpreting economic data, and avoiding hard turns of the wheel unless necessary. It is the case today that we are traveling down a winding road and have better visibility of our destination nine to twelve months ahead of us, but not necessarily clarity on how we will get there. Elevated inflation, supply chain challenges, and policy uncertainty could throw up additional roadblocks in the months ahead, but we continue to assess the longer-term outlook as constructive. We retain an overweight to equities and have modestly reduced portfolio risk by trimming our overweight allocations to commodities and high-yield municipal bonds in favor of an above-benchmark tactical cash position. Effectively, we are sticking with our optimistic expectations for post-pandemic growth and earnings while at the same time hedging against the asset price disruption that higher inflation could bring to both stocks and bonds.

Economic whiplash

The economy threw on the brakes in the third quarter, thanks to the Delta variant of COVID-19. Gross domestic product (GDP) clocked in at just 2.0% quarter-over-quarter on a seasonally adjusted basis, compared to 6.7% in the second quarter,1 as personal consumption flatlined. New job creation disappointed despite record numbers of job openings. Growth in other parts of the world, including China, decelerated at a similar rate as mobility restrictions and plant shutdowns stymied economic activity.

The near-term outlook is foggy and will depend on the answers to three important questions:

1) Where are the workers?

Job openings sit at record levels, yet the last few months have revealed disappointing job growth. Clearly this is a supply-side labor issue that is spilling over into wage growth, inflation, and supply chain problems. The October jobs report will be critical, as it is the first month with a “clean” report since the September expiration of extra federal unemployment benefits. Bloomberg consensus estimate is for a net addition of 395,000 jobs. Most important to watch will be the labor participation rate. This is the size of the labor pool measured by the number of people working or looking for work as a percent of the working-age population. This figure dropped significantly during the pandemic and has yet to recover, particularly for women. We attribute this to a confluence of factors, including generous unemployment benefits, elevated savings accounts, health concerns, childcare issues, retirements, and especially a reconsideration of the desire to work. Going forward, several of these factors will drop off and the participation rate should recover, but the acceleration of retirements observed during the pandemic could mean worker supply undershoots employer demand for the foreseeable future.

2) When will supply chain traffic jams clear?

To answer this question requires a crystal ball we simply do not have, but we do speak with experts in the transportation, logistics, manufacturing, and retail industries. Third-quarter earnings season has also been revealing, as even communication services companies like Snap have indicated that supply chain pressures are affecting their bottom lines. Our research suggests backlogs at ports may be close to peaking, but a return to normal is unlikely before mid-2022 at the earliest. The shortage of semiconductors, which has been so painful for auto manufacturers and other companies, may not alleviate until the end of next year. U.S. auto sales in September were the lowest since late 2011 and fell at an annualized rate of 54% in the third quarter2—evidence of the severe toll that supply chain problems are having on the industry and overall economy. That said, we expect the strain on supply chains to ease over the next year as workers return to the labor market and spending shifts from goods to services. Looking further out, the record-low levels of inventories create a very nice backdrop for an inventory rebuild cycle that should be supportive for growth in 2022.

3) How high will inflation go before peaking?

This answer depends very much on how answers to the first and second questions we’ve posed pan out, but our base case is that inflationary pressures start to recede in 2022. Input prices remain elevated and wage growth has accelerated, but if you squint you can start to see signs of more normal rates of inflation, particularly in the month-over-month data. Industrial commodities like copper, iron ore, and steel are already declining alongside China’s property market. We expect the Consumer Price Index to slow from a year-over-year rate of 5.4% to around 3% a year from now, which is more than 1% above the 2010–2019 average but much more manageable for businesses and consumers than today’s rate of price increases. That said, we continue to view inflationary risks as skewed to the upside, and our overweight allocation to equities remains a good long-term hedge.

Please see important disclosures at the end of the article.

A strategy that integrates environmental, social, and governance (ESG) factors into the investment process may avoid or sell investments that do not meet criteria set forth by the investment manager. Such investments may perform better than investments selected utilizing ESG factors.

1 Source: Bureau of Economic Analysis.

2 Source: Ward’s Automotive Group.

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