It’s too sunny out to think of a clever introduction to this month’s newsletter. Hopefully many of the rest of you are enjoying similar challenges. May brought continued improvement in the US economic situation, as measured both by production and employment. While inflation measures continue to compare to year-ago numbers that were reeling from the shock of the initial pandemic lockdown (I believe it was about May last year when everyone started bragging about their sourdough starters?), we are starting to see signs of meaningful price increases which are not just attributable to depressed year-ago numbers. For example, lumber prices have skyrocketed. The prices of used cars and trucks are up 29.7% from one year ago, in unadjusted dollars. (Seasonal adjustments are meant to address known patterns in prices – like strawberries costing more in December than in July.)
Lasting Inflation? Or Dramatic Re-Adjustment?
Whether these events will result in long-lasting price increases, however, remains to be seen. Usually, or according to economic theory anyway, when prices rise, more businesses are tempted to join a particular market, or existing producers increase their production. In the short run, however, there are limits to how much supply can increase. Once I’m running my sawmill 24/7, I can’t output more board feet until I build another sawmill. Things just get trickier when you throw in weird “exogenous shocks,” like the 1970’s oil crisis, or a pandemic.
In both the vehicles and the lumber markets, though, we know what is going on – pandemic-induced supply reductions followed by increased (or at least a return to normal) demands mean prices increase. In time, markets will probably do what they usually do – shift to adjust to increased demand or available profits, or replace one product with another. (3-D printed house anyone?) This isn’t terribly helpful if you are in the middle of a renovation project or need cars for your business right now, but given a year or two, human ingenuity tends to adapt well.
Guessing specifically what inflation will do, like many other economic guessing games, is a great way to spend a lot of time being wrong. One popular way to “crowdsource” this question is to look at breakeven inflation. This is the inflation rate implied by the difference between a particular ordinary Treasury note interest rate and that offered by Treasury Inflation Protected Securities (TIPS), which are also government bonds, but are indexed to inflation. Here we have a chart comparing these two items. The blue, less dramatic line is the breakeven rate, which we can interpret as a collective guess by bond market participants as to what inflation will be. From the looks of this chart, the prediction is not far enough in advance of inflation changes to be useful. This is far from a rigorous statistical analysis, but hopefully it illustrates my main point – predicting the future is a messy business at best.
Bureau of Labor Statistics
 There are other interpretations of course, as with most economic matters.
One particular price that receives a lot of attention is the price of labor – or wage rates. As employers struggle to fill open positions, lawmakers argue about whether higher unemployment compensation is providing an incentive to stay home. Once these benefits return to their non-crisis levels, however, I suspect we will also see a more permanent shift in the labor supply curve. Laborers in fields which suffered more COVID infections, such as grocery workers and health care workers, may decide their former wage rate does not adequately compensate them for not just their time but this additional, newly understood risk. Mothers, in particular, continue to disproportionally face the choice between underpaid labor in the workplace or undervalued labor in the home. I would like to assure readers that the pandemic has made clear how starkly our economy underpays and undervalues the work of childcare and education, but as with the above, we’ll have to wait and see if it sticks.
Stock markets also had a positive month, with the S&P 500 closing at an all time high (which has been passed in June) of 4232.60 on May 7. International markets did even better. US bond markets had a fairly tame month-to-month change, with a couple spikes in the ten-year Treasury yield not passing 1.7%. Initial public offerings of stocks (IPOs) have passed the total number for 2020, and the year isn’t half done yet. Generally speaking, equity markets look happy. Are they *too* happy? Ah, more guessing. Whether equity markets are “overvalued” is a great topic to get a room full of investment professionals – or really anyone interested in investing – arguing. The beauty of long-term, sustainable investing is, we don’t need to know, because success isn’t dependent on jumping in and out of markets at opportune moments. We focus on keeping costs down and selecting an appropriate asset allocation, two factors with consistently-demonstrated effect on investment returns.
One market I have been watching with horrified fascination is my local housing market. Comparing Portland, OR to the country broadly, we do appear to have had a more dramatic price increase in the pandemic than average.
The particular neighborhood in which my fiancé and I hope to purchase a four-bedroom plus office and basement house (and a pink sugar castle in the sky?) has seemed even more wild, but apparently it’s all in the timing, if we want to believe this chart from redfin.com. (That number of houses sold figure appears to be monthly, not annual, thank goodness.)
All the charts in the world aren’t going to cause some homeowner to get up one day soon and decide to sell us the house we want for a price we think is reasonable. As my first investment job boss liked to quote, “The market can remain irrational longer than you can remain liquid.” So for now, we rent, and watch, and scheme. These kinds of pivot points are stressful, and when you find yourself facing one, give us a call. We’re here to help.
|Reference||What it measures||Latest numbers||Where we got the data|
|Real GDP (Gross Domestic Product, adjusted for inflation)||Goods and services produced on US soil||Increased 6.4% over the previous quarter; decreased -3.5% for 2020 overall||Bureau of Economic Analysis (bea.gov)|
|Unemployment Rate||Share of people “in the workforce” who are totally unemployed||Declined 0.3% in May to 5.8%||Bureau of Labor Statistics (bls.gov)|
|Inflation Rate||The prices of a basket of goods deemed representative of a typical urban consumer in the US||Increased by 0.6%, seasonally adjusted, in May; for last 12 months, increased 5.0% before seasonal adjustment||Bureau of Labor Statistics (bls.gov)|
|Reference||What it measures||What it did in month||Where we got the data|
|S&P 500||US large and mid-sized company stocks||Rose 0.5% in May||Wall Street Journal (wsj.com)|
|MSCI EAFE||Large-cap stocks in Europe, Australasia, and the “Far East”||Rose 3.3% in May||MSCI (msci.com)|
|Barclay’s Aggregate Bond Index||Intermediate-term, investment-grade US bonds||Rose 0.3% in May||Morningstar (performance. morningstar.com)|
|US 10-year Treasury Yield||What interest you can earn from a 10-year Treasury note||moved 0.05%, from 1.63% to 1.58%||
Wall Street Journal