Recent inflation numbers are causing alarm bells to go off, making investors scramble to determine how best to prepare. Bob & Ben break down the underlying factors causing this spike in inflation, and the unintended consequence of “The Great Resignation.” Learn about why this is happening, why this is mostly a US phenomenon, and what this means for investors. A must-listen!
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Economic Update: The Great Resignation, Ramped-Up Inflation & What It Means For Investors
We are doing something unique. This is a hot report right off the presses here. Something that we will do periodically on this show is these things are happening in real time, we want to address them and provide a lot of value to our audience. One of the things as you get to know us, maybe you’ve been following us for a while, but Bob has a great background in economic analysis and has been doing macroeconomic analysis for many years. He has had very incredible success calling tops and bottoms, and macroeconomic trends.
What we do for our investors is we put together an annual economic analysis. We want to start sharing this more with our audience and sharing some of these insights that we’re seeing. Also, we’re doing these periodic updates. One of the big ones we’re seeing and the headlines that everyone is seeing right now is about inflation.
The headlines were, “Inflation is just transitory,” which means it’s here for a little bit, and it’s going to spike and then go back down, like we saw in the lumber prices. When lumber increased by 5 to 7 times in price, shortly once the supply chain issues were solved, it went back down. There’s a lot of nuances here.
We’re going to talk a little bit about inflation, what that means and what it is comprised of. We’re going to also spend a little bit of time on the worker shortage, which has been this big conundrum, at least it was for me. We’ve dove into this to research it and then we’re going to look at what are the implications. As investors, it’s the lens we’re always looking at from. What does this mean and how should we position our portfolios? How should we invest with the information that we know and where we’re seeing these trends going? I’m excited to dive into this. Hopefully, it’s helpful to clear up some questions you may have had with inflation.
We’ve seen headline inflation print at over 6% growth, which is concerning to investors as it should be. In fact, we’ve done our own analysis and our theme at Aspen, as well as for our audience, we want to understand the macroeconomic trends. People are way more successful if you invest with the trends than if you try and resist the trends. We’re passionate about understanding what trends are going on and investing with the trends.
Seeing this inflation happening, we were much more in the transitionary camp this spring of 2021. We went back to do with another deep dive on inflation to look at what should be our expectations and what’s the outcome. We’re going to look at what is driving this inflation, whether it’s likely to persist or not, and then what it likely means for your investments.
The first thing is this chart on the actual inflation rate. This is all the way from The Great Recession all the way to now. We’ve seen inflation start to tick up powerfully, a big print at over 6%. There are three components of this inflation in our view. First, it’s supply chain issues. It’s caused by COVID primarily. There’s consumer demand booming and then there’s wage inflation driven by what has come to be known as The Great Resignation and the job shortage.
Let’s look at all three of these components and break down everything. The first thing I want to look at is the supply chain issues. In our view, the supply chain issues are waning. When we saw lumber prices spike up, five to seven times and fall down quickly back to normal, that’s one example. When you have entrepreneurs, they’re going to figure out a way to solve a problem. When you can sell lumber at seven times, what it sold for, you’re going to figure out how to solve lumber. I guarantee you somebody was figuring out how to solve lumber.
We’re going to see the supply chain issues resolved, for example, the chip shortage. I’ve been reading reports from Intel. They’re building two new chip factories in Arizona. It takes a while to build a chip factory. This is not instantaneous in many cases, but we are going to see the supply chain issues easing throughout 2022. The supply chain issues are waning and they are transitory.
Let’s look at the other big components of inflation. One of the strongest components is consumer demand. Consumer spending is hitting massive highs. This is driven a lot by deferred demand and consumption through COVID. People are locked in their houses and they’re pining for their favorite restaurant or their favorite brew, or their favorite travel destination. They’re going stir crazy. When things are lifted, there’s massive demand.
We’re seeing deferred demand ending, but we’re also seeing a consumer that is suddenly in incredibly good shape. This was very surprising to me when I looked at the data, but this data cannot be disputed. We’re seeing booming household net worth. This is the amount of net worth in a house. This has completely skyrocketed since 2020, the last eighteen months in the COVID season. It was primarily driven by the stock market and housing prices. That produces something called the wealth effect, where people feel wealthy, they want to spend money.
The second thing we’re seeing is record personal income per capita. This is quite shocking, but during COVID, in spite of some of the news headlines about the difficulty, the suffering, and the need for the stimulus packages and all that, we saw personal income per capita take a quantum leap higher. People are earning more money than they ever have. I did the analysis of these numbers from the US Bureau of Economic Analysis and it is entirely due to transfer payments. All the direct stimulus pays, too.
You’ll be way more successful if you invest with the trends than if you try and resist them. Click To TweetI’ve been around a while. I remember when Ben Bernanke was involved with the Federal Reserve and there was a lot of concern about deflation. He had made a very famous speech called the Helicopter Speech. He said, “You should never fear deflation. If I wanted to stop deflation, I could simply drop cash from helicopters and we could stop deflation.” He’s right. It created a lot of controversies because direct payments had never been made, where direct stimulus payments to individuals had never been tried.
The stimulus in the past was always tax breaks or lowering interest rates which helps businesses and it has more of a trickle-down effect over a longer period of time, and doesn’t affect necessarily individuals. This one, you can helicopter money to individuals, that’s direct. The question is what we’re seeing what’s happening. You see record personal income and some of these things we’re talking about happening. There was a famous quote that I read. It said, “When the government robs Peter to pay Paul, you can guarantee that Paul’s going to give them a vote.”
Another shocker is that savings skyrocketed in COVID. What people did with this excess income and reduced consumption is they saved. They paid down debt and saved, resulting in large balances and healthy balance sheets for consumers at this point. As a result, you’re seeing record low debt service. The blue line here is debt service as a percent of disposable personal income. You see it as a four-decade low.
This is the total financial obligation. Again, including things like rent and autos and everything else, the consumers are in very good shape. Contributing factors here are soaring income, low interest rates, and debt pay downs. The consumers are incredibly healthy. What’s happening is consumers are spending like there is no tomorrow. This is likely to continue.
Let’s look at consumer demand. Is it going to continue? Here are the factors that are going to cause easing. One is the stimulus done, so there is no more stimulus coming. At least direct payments to individuals, it looks unlikely that’s going to happen and deferred demand is waning or at the tail end of that. The continuing factors are many, including the income gains, the wealth effect, and low debt service are here to stay. There’s high in the job market and a strong GDP growth. All would say the consumer demand is here to stay.
Given that 70% of the GDP is consumer spending, it’s no accident that GDP is on fire as well. We’ve learned what happens when you make direct payments to individuals. It is like a shot of adrenaline directly to the heart of the economy. There’s no trickle down. It’s a jolt, and extremely powerful. We’re seeing that. The third factor in this inflation scenario is supply chain disruptions. We’ve hit record-high consumer demand. The other is the Great Resignation which is causing wage inflation. Go ahead and summarize what we’ve seen there.
Putting this all together, it’s a pretty big impact, but specifically on the Great Resignation as it is now called. It’s been this very unique thing to witness in the economy from pre-COVID to post-COVID. Pre-COVID era, we were already operating at a pretty low unemployment rate and then COVID hit and unemployment spiked. There’s a lot of concern about where the economy is going to go. Restaurants and retail were shutting down.
The economy opened back up and we’re through the worst of it. We look now and the simple question is, where did all the workers go? You walk down the street on all your retail stores and you see every single one of them has a now hiring sign. I saw Domino’s is doing a $3,000 one-time sign on bonus to deliver pizzas. There’s an enormous need for workers.
The simple question is, “Where did everyone go?” Did everyone disappear in 2020? It’s a lot more nuanced than that as we dug into it. There was a great piece by journalists of the Wall Street Journal that delved into this. We’re going to plot some of these pieces of information, but what’s interesting is that the unemployment rate is low again. We are back to where we were before, but the real big difference is the labor participation rate. What that means is measuring all those workers that are in the workforce.
The percentage of the population that wants to work has shrunk. They decided to retire, stay home with their kids, or do a side hustle. We’re seeing a massive amount of people that have simply left the workforce, about 4.3 million, according to a Wall Street Journal article.
4.3 million is a very big number. To your point, a lot of these Baby Boomers that are maybe close to retirement age, because the stock market has been doing well and has been hot, and everyone’s household net worth is booming, a lot of them decided to retire early. You have these dual income families where both spouses are working and there’s been a huge issue in daycare staffing. If you have kids and daycare staffing is an issue, they’re raising rates on daycare, and at the same time their wages are increasing, it makes sense for one of the spouses who may have gotten a raise that can now cover the difference between what the other spouse is making minus the daycare costs.
It’s very difficult to separate economics and policy. Every policy has an economic impact. Click To TweetThey’re ahead by only one spouse working. The other spouse stays home with the kids. It remains to be seen, but there is some concern that this is not just a short-term issue. It’s a systemic issue that may be here for a little bit with this labor participation. It’s also pretty uneven. It’s not been all across the board. It’s mostly on uneducated workers.
It’s more on them, on women, workers without a college degree, and on low paying service industries. We’re seeing outsized drops in the participation rate and jobs disappearing. On the chart here, this is the participation rate. There’s the prime age participation rate here and there’s a dropdown during COVID and it’s been recovering, but not that strongly. This is men here has recovered a little strongly and in women is not been recovering that much.
To Ben’s point, what’s happening is you look at the marginal gains from a spouse getting a job, having commute costs, daycare costs, and tax increases that it’s not worth it. I want to make the point here, too. This is not a political show at all and I don’t want to hit politics, but I do want to hit policy. It’s very difficult to separate economics and policy. Every policy has an economic impact.
I want to hit those things without making it political. The first thing I want to make a point about with this participation rate drop is this is an entirely US phenomenon. We’re not seeing this anywhere else. It is primarily US policy-driven, this issue. This working spouse phenomenon, when you count progressive taxation, you’re penalizing incremental dollars earned. That’s one more reason. Add that to daycare and commute costs. Maybe it’s easier to stay home, especially when you lose the tax breaks. The tax breaks, you’re lost in chunks.
Once you hit about $70,000, $80,000 a year, incremental dollars can put you in a different tax bracket. All of a sudden, you lose major tax deductions, you hit $100,000 even more. The marginal interest in working simply goes away. It is clearly stimulus-driven, because of the increase in wages and savings, people are feeling like, “Who wants to work? I can take time off. I’m going to retire.” One or the other.
Also, a less contributing factor, especially frontline retail hospitality type jobs, are immigrant workers. The borders have been closed because of the pandemic, a lot less people coming in. There’s less labor from that standpoint as well. It’s causing a lot of these service-based businesses to have to dramatically change how they’re doing their business and also push those increased costs.
I want to make a policy comment here, too, that America needs a smart immigration policy. Both extremes are nut jobs. We don’t need a completely closed border. We need a smart open border where people who are not criminals and who want to work and are not going to burden the social welfare system, and who are knowledge workers and are hard workers, we want them to come in. It’s good for them and for us. We need a smart immigration policy and politicians that will implement a smart immigration policy. It’s super important.
I want to look at interest rates here and make the point that we’re seeing negative real rates. Real rates are the difference in interest rates and inflation. If you look at inflation expectations right now, it’s called the ten-year breakeven rate, and it is the investors’ view of expectation of inflation. It’s super accurate. This is what smart investors are betting that the inflation rate is going to be. It’s over 2.5% and it’s approaching 3%, not close to the 6%.
If you look at the actual interest rates, 1.7%, the difference is negative. Negative interest rates mean that the cash value is decreasing. The value of it is being inflated away. Cash is burning, it’s on fire, but if you put that money in a bank in interest, you buy a treasury bond, you’re earning less than inflation. What that means, it’s going to create massive demand for assets. I’ve got cash that’s literally disappearing while I’m looking at it versus an asset such as real estate that is increasing in value with inflation. I’m going to turn my cash into hard assets. That’s exactly what we’re seeing in this environment.
Historically, looking at commercial real estate is priced 100% based on cap rate, which is a multiple of operating earnings. Cap rates are highly correlated to real interest rates, not nominal interest rates. Nominal interest rates are the headline interest rates, but interest rates, less inflation. Cap rates now are being driven to the floor. That is likely to continue. I want also to make a point about the CPI. Here’s our CPI chart from before. I want to overlay that with changes in housing prices. Housing prices go up in inflation, which everybody knows that.
For those that are maybe less accustomed to inflation and the definitions of that, there are the two broad measures of inflation which are CPI and asset price inflation. What we’ve been talking about is mostly consumer price inflation.
There were some great studies done that showed that when real interest rates go negative, housing prices spike. When real interest rates go quite a bit higher, then housing prices slow. This makes sense. This is all based on data pointing to real estate as a good investment. I do want to make the point too, the negative real interest rate is a super rare phenomenon.
For every measure of consumer prices, you’re going to see much more measures of asset price inflation. Click To TweetIt’s also likely to continue because it’s primarily created by central banks, and they’re going to continue. As soon as they had negative interest rates here, look at what happened to the real estate prices and home prices. They’re correlated. The bottom line is I want to give you the outcomes that we’re looking for in this time and how to be successful as an investor.
To recap, the supply chain disruption and the inflation through the supply chain is transitory. We’re going to see that being solved gradually throughout 2022. I predicted that for 2021, but I didn’t see Delta coming like it did. It’s still going to happen. We’re going to see massive easing of the supply chain issues. Consumer demand, we’re going to see continuing but easing. The consumer demand is going to continue to go high. GDP is going to continue record growth for the reasons I said. The stimulus has done and deferred demand is waning, but all the other drivers of an extremely healthy consumer, they are not going away.
I saw some people predicting an economic crash. Honestly, please don’t listen to that stuff. It’s not accurate. We’re not going to see that anytime soon. The Great Resignation is also continuing but easing at a slower pace. It’s going to continue than not, but as people run out of cash and as the savings diminishes, people are going to going to look at entering the job market again.
What does all this mean for us? Bottom line, as we’ve learned since 2012, inflation is bifurcated into CPI and API. When you see high consumer price inflation, CPI, you want to understand that asset prices are also going to go up. In fact, more of the easing that’s going into the economy does not flow into consumer prices as much as it flows into asset prices.
For every measure of consumer price, you’re going to see much more measures of asset price inflation. I believe the Fed is going to be very much pressured to raise rates. You’re going to see now with 6% inflation. There are keeping the rates at this super low term. They’re going to be highly pressured to ease the overheated economy.
At the same time, they’re going to be limited to by midterm elections coming up here in 2022, who’s going to want to raise rates right in front of app. In 2024 as well, when Biden’s coming up for reelection again, I see the same issue. In the past, the Fed has not been as politicized. The Volcker days in the ’70s, the Greenspan days in the ’80s and ’90s, the Bernanke days, the Fed chair position has gradually become more politicized because they’re appointed by the president.
In the past, that was more of a banker and no one thought about or paid much attention to it, but now it’s become front and center and part policy. You want to get the right person elected. My guess is they will probably try to raise rates or raise rates slightly, but they’re not going to raise them very much. You’re going to see negative real rates drive up asset prices. We are going to see asset prices continue to rise, including the stock market, Bitcoin, gold, silver, especially real estate.
We’re going to see CPI rise, but unevenly. Locally produced goods and services are going to continue to be the hardest hit. You’ll see restaurants much raising rates, cutting hours, trying to survive in this difficult environment and implementing lots of more automation and those things to try and stay in business.
You’re going to see anything that can be off shored to be off shored. You’re going to see an offshoring boom in manufacturing. For example, all this inflation that’s hitting in America, it’s not at all hitting an Asia, zero. Europe is having slightly higher inflation, but not much. It’s a US phenomenon because of the stimulus creating this outsized consumer demand and the Great Resignation has spiked inflation. For every action, there’s a reaction, then an unintended consequence.
My final prediction is that we’re going to see a reshoring boom. “Which is it?” Especially in strategic goods. Things like chips, where the cost of that chip is little, but its strategic value is high. We’re going to see strategic reshoring of various rare earth metals and chips and other things will be reshored to America to eliminate supply chain issues from continuing. We’ll see all of that. The bottom line is get ready for asset prices to continue rising.
As an investor, what does that mean? If the consumer price inflation is increasing, that means asset price inflation will be increasing. Where should we be investing? How should we be posturing?
Number one is real estate. That includes both residential and as well as commercial real estate, I believe is going up again. The stock market is going up. It’s hard to predict the stock market going up though, because it’s already gone up much, and it’s got much froth built-in. How high can a tree grow? It can grow higher. Demand is going to continue.
There’s so much liquidity. When your cash is on fire, that means at a 6% inflation rate, your cash is decreasing in value at 6% per year. You need to breakeven and earn 6%. What do you do? You’re going to be looking for high yield and everything else. Those numbers might ease a little bit here, but we are going to see higher inflation.
One other point when inflation is going up, that’s good for borrowers. When you have fixed rate debt and you can borrow at a fixed rate, and then the value of that dollar decreases over time because of inflation.
Cash is on fire. The more you owe, and let it burn. That’s right. One the keys to prospering in an inflationary environment is fixed rate debt. It’s owing a lot of fixed rate debt.
Thank you for joining us. We hope this was helpful. Again, this is a special news report here. If you have questions on this, we are very communicative and want to hear your feedback and other things that maybe you’re thinking about for issues that you see economically and other things that you would like more analysis on. We’re always open to try and put out as much helpful content as we can. Thanks for reading. Go be successful in your investing. Hopefully, this will give you the tool to do so.
