Gordon Telfer, CIO, Co-Portfolio Manager, Newday Impact
Overview
This month’s note tackles falling COVID-19 cases, a wide range of economic developments, and the big three issues on my mind right now: the Chinese economic slowdown (a rising concern), supply chain issues (an ongoing but slightly diminishing concern) and inflation (a serious and now steady level of concern).
COVID-19 infections mostly falling
COVID-19 remains mostly in retreat. This is true across most of the U.S., and much of the developed and emerging world.
Global COVID-19 cases and deaths
10/17/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM
That being said, a few prominent exceptions do exist. It is notable that places like Australia and Singapore, which both recently abandoned zero-COVID policies, both have experienced a surge of new infections. Further, there is tentative evidence that infections are beginning to rise again in parts of Europe. This includes Germany, France, and the Netherlands. We continue to monitor developments closely, as we head into winter in the northern hemisphere.
A wide range of economic developments
I follow multiple economic indicators. The following are some of my favorites:
Real-time measures of traffic congestion find that European traffic levels at both morning and afternoon rush hours are now back to their pre-pandemic norms. This is ahead of most North American and Asian cities, which remain shy of prior norms. We view this as a proxy for a return of workers to offices, but I think it also says something more broadly about the normalization of daily life. Admittedly, to the extent that public transit has become less popular, it exaggerates the extent of normalization.
Mixed traditional U.S. data: U.S. payrolls for September landed at +194,000 jobs, less than half the consensus number. But this disappointment was tempered by the fact that upward revisions uncovered 169,000 additional jobs over the prior months, and more workers were absorbed than would be strictly required to keep abreast of population growth. Although 5 million more Americans remain unemployed than before the pandemic, the unemployment rate has nevertheless fallen to just 4.8%.
U.S. jobless claims hover around pandemic low
Week ending Oct. 2, 2021. Shaded area represents recession. Source: Department of Labor, Haver Analytics.
It should be said, that while the rate of hiring has seemingly slowed, the level of initial jobless claims has continued to improve. It registered just 293,000 new initial claims in the latest week. This number is near to the 222,000 registered in the last week of 2019 – a half-century low – and is many miles away from the more than 6 million new jobless claims registered in the worst week of 2020!
Finally, the twin Institutes for Supply Management (ISM) indices for September, suggest that the U.S. economic deceleration may be ending. The Manufacturing component rose to a robust reading of 61.1, the highest in four months. And the Service measure clocked a solid 61.9. This was the second highest reading in four months and spectacular by any normal standard. As such, the Federal Reserve can probably still begin its tapering operations before the end of the year. This move has been sufficiently well telegraphed, that I believe it should already be priced into the stock and bond markets.
The Chinese economic slowdown
The Chinese economy slowed sharply in the third quarter, reporting a “mere” 4.9% year-over-year increase. But the real story is hidden within this figure. The new quarter – the quarter from July through September – yielded a mere 0.2% increase. This is a tiny addition for a country like China that is used to a growth rate around 7 times faster each quarter. Growth should be somewhat better in the fourth quarter, but still significantly lower than normal. Further, we model for a sub-5% growth rate in 2022. This is well below its pre-pandemic norm and below the consensus forecast, albeit still quite good by the standards of nearly any country, other than China.
I do want to be clear, none of this is because China’s pandemic economic recovery is stalling out. The economy long ago recovered from most aspects of the pandemic. Instead, it reflects several more recent headwinds:
- Insufficient electricity for factories (We think short-lived)
- Global supply chain problems (We think remain distorted for several more months/quarters)
- The Chinese government corporate crackdown, skewed toward the tech sector (We think near-term negative, but longer-term could be positive if it creates additional competition into the economy)
- Housing market excesses, as government rules tighten and industries tied to real estate feel the pressures (We think the property sector will continue to be a drag on the economy)
Supply chain issues
Supply chain problems are likely to persist, to some degree, possibly for years given the world’s transition to just-in-time (JIT) inventory systems. The auto industry has been particularly affected due to a shortage of chips. As a result, there just are not enough vehicles to meet demand. For example, U.S. passenger car sales, in September, fell by 25%. However, it must be conceded there have recently been several important improvements to the supply chain dynamic, and that the intensity of the problems should fade with time. For example: The number of container ships waiting at anchor, or in holding areas, for their turn to unload at either of Southern California’s two main ports has begun to edge lower, for the first time since last spring (see next chart). Part of this may be attributable to the fact that the Port of Los Angeles will now operate 24 hours per day (in keeping with most other major ports). This is a very important development, as the two ports unload an incredible 25% of American imports.
Container ships at anchor or in holding areas
As of 10/14/21. Marine Exchange of Southern California
In short, the situation looks better than before, but it is a long way from being completely resolved. We expect significant disruptions for several more months, moderate disruptions for several quarters, and then lingering distortions that may persist for a few years. This is both growth-negative and inflation-positive.
Inflation tidbits
There are many short-term inflation drivers at work right now. These include supply chain issues and a spike in commodity prices. The term “transitory” in the context of “high inflation is transitory” has become way over-used in my opinion. The reality is that what was initially thought to be an inflation spike lasting a few months, last spring, shows little sign of abating.
Energy costs have long ago revived from their initial pandemic collapses. Prices have lately pushed significantly beyond the pre-pandemic norm. For example, West Texas Intermediate (WTI or NYMEX) crude oil prices per barrel, as of October 29, 2021, is now $83.57 per barrel, the highest in seven years. Natural gas prices have increased to an even greater extent, with UK and EU contracts trading at up to 10 times their start-of-year levels. Coal prices have now also soared, in significant part, as coal is used as a substitute for natural gas, but also due to a dispute between China and Australia. The global benchmark thermal coal price is now trading at triple the price of late 2019. All these developments are broadly bad for economic growth (with exceptions for energy-producing nations) and contribute to higher global inflation.
Scotsman’s View
As an investor, all of this suggests to me there may be less room for company profit margins to rise further in the future – a challenge for all of us who have benefited from the prior increases. Wage growth may rise somewhat more quickly than expected given shortages in workers, and employees may succeed in negotiating other benefits, such as working from home. Inflation could be higher, (though we think demographic changes and increased productivity via technology and other forces remain net deflationary and might outmuscle this effect).
For me, this episode also illustrates that our new era of decarbonization brings with it a few important implications, as demand pivots away from fossil fuels. Companies and investors are now reluctant to invest further into fossil fuels because peak demand arrives within a few decades. In turn, I believe we should expect greater energy price volatility because suppliers will respond less enthusiastically to positive demand shocks or negative supply shocks. That is arguably part of what is transpiring now.