“Every administration thought they had power to end inflation but they really didn’t. I think now you can see that same sense of overconfidence in the ability of the government to control inflation.” Richard Curtin, an economist at the University of Michigan
It’s a vicious cycle.
Higher prices can lead people and businesses to expect inflation to continue uninterrupted into the future.
This “inflation psychology” can feed off itself, creating even higher prices.
Workers ask for raises, expecting a higher cost of living.
Consumers accelerate purchases fearing prices will rise in the future.
Businesses increase prices to pass along higher input costs to consumers.
This can create a feedback loop of higher inflation today and expectations for higher inflation tomorrow.
As investors, we know that trends can change quickly. There isn’t a blinking neon sign that indicates inflation has peaked.
What does peak inflation look like?
These are economic and consumer behavior indicators that could signal the worst of the inflation cycle is behind us (we aren’t there yet, but there are signs).
Inflation data is reported in the rearview mirror. For example, in April 2022, we get inflation data from March. Peak inflation could come and we wouldn’t know it for a few months.
Transportation
Source: LPL Research
The above graph shows deep-sea shipping costs from Shanghai going back to 2018. While deep-sea shipping rates have receded, general freight trucking is showing no signs of slowing. Last week, Amazon added a 5% seller fee to partially offset “fuel and inflation.”
*We realize the COVID lockdown in Shanghai could reverse the cooling of shipping costs.*
What we are looking for: Transportation costs to peak and rollover
Inventory Build-Up
Source: U.S. Census Bureau
The above graph shows business inventories divided by sales (2013 – April 2022). A rising line would indicate people are buying less stuff, which should put downward pressure on the price of goods (higher inventories, lower sales). Notice the huge spike in early 2020, nobody was buying anything due to COVID. How quickly things have changed!
What we are looking for: Inventory levels to increase
Consumer Spending
Source: Bespoke Investment Group
The above graph shows the monthly change in retail sales. Notice the huge drop in spring 2020 and the massive spikes when stimulus payments hit bank accounts. While retail sales are still positive month over month, the pace of growth is slowing (far right).
Source: Bespoke Investment Group
The above data set shows retail sales by category. The highlighted gray column shows current levels as of March. The last two columns show retail sales and year-over-year changes in spending from March 2021. Red highlights indicate lower levels of spending vs. one year ago.
Source: Bespoke Investment Group
The above graph shows year-over-year growth for non-store retail sales (online sales). This is perhaps the most surprising March spending metric. While the number is still positive vs. March 2021, consumers are buying less stuff online.
Source: Bespoke Investment Group
The above graph shows University of Michigan’s April Consumer Sentiment survey. When consumers feel gloomy, they tend to spend less money. While consumer sentiment bounced in April, Americans aren’t feeling too optimistic about the economy. The current levels are in-line with the Great Financial Crisis of 2008-2009!
What we are looking for: Consumers to stop buying so much crap.
We highlighted that much of the inflation problem is demand-driven. See “How to Solve the Inflation Problem.”
Much of the economic data we are tracking is tied to the spending behaviors of the U.S. consumer. We are also tracking gas prices, housing, mortgage rates, and wages.
The wildcard is predicting how future consumer behavior will change (which is why it’s so difficult to predict inflation).
For example…
Buying salsa instead of guacamole because avocado prices are high.
Buying an electric car and selling a gas-guzzling SUV.
Dining in vs. dining out.
Taking one family trip vs. two family trips.
Humans will not keep doing the same things in the face of rising prices. Price changes lead to behavior changes.
We will substitute higher-cost goods for lower-cost goods, make trade off’s, change our preferences and consumption behavior.
If you are piling into inflation/rising rate investment themes, these crowded trades can reverse on a whim. There’s no announcement that inflation has peaked. The market will sniff out peak inflation and reverse course before most investors recognize what’s happening.
Drop us a note at insight@pureportfolios.com for more on inflation & investing.