Ashley Gardyne: Growth or stagnation — which road will it be?


While lockdowns continue in New Zealand, the global economy and financial markets have all but put Covid in the rear-view mirror.

Consumer spending in most countries is back to pre-Covid levels, as is US industrial production, house prices, wages and employment.

Two very different pictures are now being painted of what comes next. Are we in for high inflation (or even stagflation), or a return to the low-inflation and low-growth world of the past decade?

The economy marches on

Looking beyond our borders, most countries are gradually learning to live with Covid. Lockdown rules have been rolled back, offices have reopened and people are travelling and dining out again. Consumers are flush with cash and are now out spending.

In Europe, visits to shops and entertainment venues have now almost fully recovered to pre-pandemic levels. In the US, domestic traveland hotel occupancyare back near 2019 levels.

United States industrial production is also back to pre-pandemic numbers and consumer spending is at all-time highs. This has all flowed through to rosy economic data, strong corporate profit growth and sharemarket indexeshittingrecords.

But this strong economic momentum has also caught many industries off guard. The rapid surge in demand has led to product shortages, shipping bottlenecks, a shortage of labour — and as a result, a level of inflation we haven’t seen for over a decade.

The path from here is a guessing game. Will we see continued high inflation, or are these factors temporary? The answer will determine the speed with which the US Federal Reserve tapers itsquantitative easing and starts to hike interest rates — two factors that have had a major impact on markets in the past.

Inflation returns

The spike in inflation has also seen the return of a term thatmanythought had been relegated to economic textbooks: stagflation.

Shipping costs have surged by over 200 per cent in the past year and oil prices have almost doubled, putting upward pressure on the price of everyday goods. Even used cars, an asset class I would never really have expected to experience inflation, have seen their prices jump over 40 per cent compared to pre-pandemic levels.

All these price increases have links to supply chain issues driven by Covid. In the case of shipping costs, the boom in demand for goods (instead of services like dining out) has seen a spike in shipping from China to the developed world. This has led to a bunch of empty containers in the US and Europe, with a smaller number returning full of exports due to lockdowns reducingproduction. This has resulted in a shortage of shipping capacity out of China and a spike in freight rates.

Similarly, a drastic shortage ofcomputer chips has had an impact on the vehiclesupply chain. The production of new cars has been severely hit:Toyota, for example, slashed global production by 40 per cent in September. This has had a follow-on impact on demand for used cars (as there are not enough new ones), pushing prices higher.

These price increases are causing employees to demand higher wages, which is further helped by a shortage of labour. This shortage is illustratedby sign-on bonuses in the US fast food industry, where even McDonald’s is offering $500 starting incentives.

Some people are sayingthis will lead to a structural pickup in inflation. When the economic surge caused by reopening dissipates, we could be left with elevated inflation and a stagnant economy — or stagflation. That would cause a real problem for central banks, which could be faced with the need to hike interest rates to head off inflation, despite a weak economy.

But is ittemporary?

Others argue that this environment of high inflation is unlikely to persist. Supply chain bottlenecks and labour shortages will be worked through in time. We have already seen this with lumber prices, which spiked last year and were up by over 300 per cent at one point, buthave now returned to near pre-pandemic levels.

Some of the more recent economic data also shows that the surge in growth could be short-lived. Recent US employment figuresshowed thathiring slowed in August and September, enhanced unemployment benefits and stimulus cheques are coming to an end, and there are signs that the post-reopening spending surge may be starting to dissipate.

This could leave us with the disinflationary forces we have lived with over the past decade — including high debt levels and demographics that create a structuralheadwind for growth. If this scenario plays out, then the outcome could be a continued accommodative stance by central banks and interest rates that stay lower for longer. This would be much like the benign environment we have been in for much of the last decade.

Corporate fundamentals matter most

I have painted a world of two extremes and a near-term fork in the road. But in markets, there are never just two possibilities, where one leads to good outcomes and one to turmoil. There area myriad of paths the economy and market could head down.

Since the global financial crisis, we have been warned of numerous existential risks for markets: the European debt crisis; the China trade war; Fed tapering; the Trump administration; the Biden administration — and the list could go on. These sorts of events often cause short-term volatility, but five years later they seldom matter.

What does matter is picking the right companies to invest in and holding tight through thick and thin — not getting deterred and selling due to macroeconomic ambiguity. That said, while the going is good, it makes sense for investors to check in and make sure their investment strategy is one they could stick with should volatility resurface.

– Ashley Gardyne is Fisher Funds’ chief investment officer.

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