Inflation: where does the market sit?
A short and sharp update this week.
As covered in our CIO Video Update for August that you may have watched yesterday, we have seen some astonishing CPI prints over the past year.
This has mostly been put down to base effects (cycling very low inflation during COVID) as well as supply disruptions across a few key industries, namely in vehicle prices (itself a knock-on effect form a shortage of semi-conductors), hard and soft commodities (lumber, oil, food) and elevated shipping costs.
We can see this below. Core CPI (excluding ‘volatile’ items in baskets related to energy and food) has spiked dramatically this year. However, excluding autos, the lift has been much less pronounced.
Source: Minack advisors
You therefore would be excused for thinking the most recent bout of inflation is ‘transitory’. A weaker than expected CPI print for August in the US has supported this view this week.
However, we point to some other charts that indicate there may be more ahead.
With the easing of restrictions on rent increases and evictions, shelter costs look like they are at an inflection point in the US:
Source: Minack advisors.
The labour market is getting tighter as it gets harder to find more workers. This is a sentiment we have heard echoed by companies we have spoken to that are based in the US.
Source: Minack advisors.
And lastly, producer prices continue to rise:
Producer prices continue their rise
Source: Bureau of Labor Statistics
We are of the view that the risk of inflation sticking around for longer is under-priced. But what is the market’s view?
The market view:
Aside from market-based indicators – such as the yield on inflation protected securities, fund manager surveys can be a good indicator of expectations.
This week Bank of America released its monthly survey of fund managers – a global survey of approximately 200 institutional, mutual and hedge fund managers around the word.
The responses give some insight into where the current ‘consensus’ sits.
The chart below illustrates that there is an equal number of fund managers that see inflation trending higher to those that see it trending lower.
More or less inflation? Opinions split down the middle
This survey question is of course distorted by current levels of inflation – the real question we are trying to answer is whether the majority believe inflation will be a transient or more permanent phenomenon.
Conveniently, the Bank of America survey asked this question too.
The results were: an overall and growing majority see inflation as a transient phenomenon, as shown below:
Under-priced: 69% of investors think inflation will be transitory
To us, this provides further proof that the ‘consensus’ is pricing-in very little risk that inflation may be here for longer. Given the potential consequences for market prices overall of rising inflation, we prefer to have a more cautious outlook – with a healthy holding of cash and a tilt towards companies that are likely to be resilient in an inflationary environment.