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Core Comments Quarterly Newsletter, 1st Quarter, 2022


January 13, 2022


Last quarter I started with what turned out to be an unfulfilled wish. I assumed that if no new variant followed Delta, we would be back to living a “more normal existence”. Well so much for that and hello Omicron. Yes, we are into our third year of disruption of our lives and the economy of the whole world although there are strong reasons to believe that the Covid nightmare will come to an end but, I’d rather not say when. Covid is on its own schedule, and it will end when it decides but there are some positive signs. Omicron does not appear as deadly as the earlier variants despite being much more contagious. Once again hospitals around the world are filling up with new patients and once again, we hear nightly of shortages of ICU beds and medical personnel who are stretched thin. Hopefully this will be the last time.


Covid certainly did not dampen the stock market with the S&P 500 gaining 28% for the year and corporate profit margins reaching record levels. 2021 was one of those unique years that did not have a market correction. These happy results were due to a continuation of the stimulus led rebound from the Covid low in March 2020, but this economic resurgence has likely run its course. It is thought that economic growth will moderate in 2022 causing the market to produce modest gains. It is also thought that inflation and the Fed’s work to contain inflation will lead to more volatility and possibly a market correction. Initially the Fed said that inflation was transitory, meaning that its effect would last a matter of months due to Covid related disruptions. It seems that this will be the case with many of the inflationary issues like the back up at our ports or the lack of chips for the automotive industry. Although the period of months might turn out to be a year or more. Anecdotally, it appears to me that there continues to be a shortage of cars on auto dealer’s lots.


In June the headline CPI was reported to have grown 5.4% over the past year. By November it grew to a 6.8% rate, and some believe that it could hit 7% in coming months. Just a few years ago, the inflation rate was under 2% and the Fed was trying to raise it to help stimulate the economy which had been sluggish for years. Well, it seems they succeeded but they were not alone as the Fed controls monetary policy while the Congress controls fiscal policy i.e., Spending and Taxes. When Covid came along the Congress responded with spending designed to prop up the economy. The resulting inflation seems ominous especially when Ten Year Treasury Notes yield 1.5%. As you would expect attention is now focusing on controlling inflation. The recently released minutes of the Fed meeting in December revealed that they discussed increasing interest rates in March rather than waiting until June or July causing a sharp selloff in equity markets.


There are two major problem areas in the inflation puzzle, labor and energy, that are not likely to go away quickly. The US has 10.6 million unfilled jobs and 6.3 million of unemployed workers. The essence of the problem is the number of people who have left the workforce and cannot be easily replaced. Covid has caused the number of retirements to be significantly greater than what was expected, and a growing number of people have become selfemployed to avoid contact with the public. These groups are not likely to return to the labor force. On the other hand, there are large numbers of people vaccinated but not working because they are afraid of catching Covid, there are working people who cannot find childcare and there are unvaccinated people who left the work force due to vaccine mandates. These groups could relieve the shortage of workers once Covid is in the rear-view mirror but in the interim the shortage of labor will lead to rising wages as businesses compete for the workers they need.


The energy aspect of the inflation is the result of our climate policy. Demand for fossil fuels has remained steady but capital investment by energy companies has declined significantly reducing the supply and thus we have prices rising. The transition from fossil fuels is moving slowly but energy companies are under increasing pressure to reduce their carbon footprint creating a mismatch in the economy. Perhaps the plan is to make the fossil fuels so expensive that people shift to the alternatives, but this brings in significant costs for those willing to purchase a new electric vehicle or a new electric heat pump for their home. Basically, there is a conflict between government policies for lower inflation and those for lower carbon emissions. I suspect that most of the volatility this year will come from how we solve the labor, and the energy shortage issues.

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