The Monthly Five Author Avator

Katie Nixon, CFA, CPWA®, CIMA®

Chief Investment Officer, Northern Trust Wealth Management

September 17, 2021

Your Questions Answered

Our Investment Policy Committee met this week for its monthly discussion of economic and market conditions. With COVID-related crosscurrents, continued supply chain disruptions and patient global central bankers, there was much to discuss.

Here are the five key takeaways.


Economic growth will be more subdued in 3Q due to the rise in the Delta variant.

However, we anticipate that the shortfall will be recovered in 2022. This is based on a COVID-related slowdown in demand, along with the continued supply disruptions that are leaving some shelves relatively bare — impacting demand. You can’t sell what you don’t have, and the surge in the Delta variant has impacted some key suppliers in Southeast Asia, where the surge was acute and lockdowns were imposed, which curtailed manufacturing. As infection curves are flattening, we anticipate a stronger 4Q; however, it remains to be seen whether the worst of this wave is behind us in the U.S. — schools recently re-opened in many states, which has historically preceded a spike in cases. Further, we observed cases falling in the UK, only to rise again. And last, the COVID infection rate in Israel continues to climb despite a very high vaccination rate. For investors, this uncertainty likely means that central banks will continue accommodative measures — tapering is not tightening, and rate hikes are still only in the distant future.


On the inflation front.

We had anticipated that our “stuckflation” theme would be tested, and it has been, as both consumer and producer prices have risen dramatically from the spring 2020 lows. That said, we have seen some moderation in consumer prices, particularly in those areas that were most impacted by the pandemic — used cars, rental cars, airline tickets, hotel rooms. The decline in those prices in August led to a lower year-over-year core CPI print of 4%, a 0.3% easing from the July data. It is likely that inflation peaked in 2Q. However, we do anticipate that the data over the next few months will continue to be noisy, with still-accelerated housing costs capturing attention, but perhaps offset by more normalized wage inflation keeping unit labor costs contained as job seekers re-enter the workforce. For investors, the moderation of inflation — albeit at a relatively high level — will allow the Fed to focus more directly on the labor market and its full and inclusive employment mandate. This will keep the Fed’s interest rate policy on hold for quite some time.


One area of inflation that we continue to watch: supply chain disruptions remain acute.

The number of container ships stuck outside the Los Angeles and Long Beach ports is beyond the peak hit in winter/spring 2021, and container costs are currently 7X pre-pandemic rates. In addition, there remains a significant shortage of truck drivers in the U.S., and nearly 70% of all freight is moved on U.S. highways. There are several driving forces behind this shortage, including the fact that, according to the Bureau of Labor Statistics, the average age of a commercial truck driver in the U.S. is 55 years old — so the retirement boom we have seen over the past 18 months clearly influenced the current shortage. Shortages and bottlenecks throughout the supply chain could have serious implications for the holiday season and could extend the period of “transitory” inflation well into 2022. As noted above, the logistical challenges present a growth headwind and an inflation tailwind.


Resilient Resilience.

Despite the surge in the Delta variant and the resulting slowdown in economic activity, consumers remain resilient. U.S. retail sales increased 0.7% in August against an estimated decline of -0.7%. Looking at the details, it is likely that back-to-school shopping was impactful as students prepared to return to in-person learning. Spending was also supported by the mid-July child tax credit program. Economists had become more pessimistic on consumption, particularly given the decline in consumer confidence reflected in the University of Michigan survey results. As always, we watch what people do, not what they say, and this apparent dichotomy is a solid proof statement that words and actions don’t always align. We continue to see resilience at the consumer level and at the corporate level, as earnings expectations are rising despite the Delta wave. Even under the most recent proposal to raise the corporate tax rate from 21% to 26.5% (note, this is a just a proposal at this stage) we estimate the cut to 2022 earnings to be roughly 5%. For investors, this is a reminder that fundamentals remain strong: Demand is not an issue.


Raising the roof.

A quick note on the debt ceiling: With House Democrats working feverishly on the reconciliation bill and having already seen some opposition from party moderates to the drug pricing proposal, the next several weeks in D.C. will be action-packed. At the same time, the looming issue of the debt ceiling will have to take center stage. Secretary of the Treasury Janet Yellen has warned that the “extraordinary measures” currently being taken to support government spending will effectively run out earlier than anticipated — perhaps mid-October. This leaves us with a tight time frame, a deeply divided political landscape and extremely high stakes: Without lifting the current $28T debt ceiling, the U.S. is in danger of default and downgrade, and the consequences will likely be felt by investors as markets gyrate. Our base case is that a deal — last minute — will be struck, as it is in both parties’ best interests to avoid a default. However, the risk case is that consensus is not met, and we would expect risk asset markets to react much as they did in 2011 — initially “risk off,” which could actually be exacerbated this time given the current environment of low volatility and high valuations.


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