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Financial Industry Insights from Advisors Asset Management
On December 14, 2020
AAM Viewpoints – The Pivot Point for 2021
In a year filled with a cacophony of conflicting messages and each one portrayed as the real black swan event to change the world, it seems overly provincial to narrow the next year down to one metric. However, when this metric is and has been highly disregarded as a material issue anymore, it seems those events approach a level of blind spot that transforms markets. This transformation often is violent in that its ramifications are matched with the pace at which it takes place. We will have our more detailed 2021 views out at the beginning of the year where we felt that many late year economic and political events drove us to be more prudent in our projections as it can affect the degree and timing of our projections.
There are many metrics that could meet this criterion; however, we believe it’s inflation. When the word “inflation” enters the conversation, it is usually met with two differing understandings. First, it is nonexistent as globalization is disinflationary at worst and we have heard this projection before. Secondly, the message is seen as a call that the hyper inflation of the 1970s and early 1980s is imminent. To the vast majority, there is no middle ground. This dichotomy creates a small amount needed to incur dramatic change.
Inflation does not have to be hyperinflationary or deflationary to make a major impact on the markets. Inflation alters the environment for equity in the form of multiples and demand for differing forms of capital, to name a few. It substantially alters the environment for fixed income in that it erodes value of current income and forces more active attention to the portfolios and credit ratings. It also has substantial impacts on currency as it erodes value of the fiat currency in the markets, which is being exacerbated by historic budget deficits caused by the pandemic.
The Federal Reserve has two mandates, though that has morphed into a fill-in-the-blank third mandate over the last few decades. The mandates simply stated are to maximize employment while maintaining stable prices and moderating long-term interest rates. The concern about inflation has been a distant thought with how the qualitative measure of inflation has been utilized. The range of inflation has adjusted to a lower range due to the modern economy and productivity improvements via technology and manufacturing and shipping to name just a few.
The Federal Reserve is doing everything possible to initiate inflation by saying they won’t raise rates for three years, let inflation run high, and be a perpetual buyer of debt in multiple forms to creating market liquidity in small business forms not seen. As of this writing the legislative process is once again letting down the small business owners and households in dire need of support in the form of timing and delayed implementation, the Federal Reserve must be commended on their recognition of the problems the pandemic has caused. With the Federal Reserve having a loose target of 2% inflation rate, it is important to look at what is happening in both historic and peripheral issues to influence inflation.
There are various forms of inflation to be sure. In economic terms it is often broken into two categories: demand pull and cost-push inflation. Demand pull is driven by consumption and as its moniker states, over demand pulling prices higher. Cost pull is an inflationary component where the inputs to produce the good increases. Some of the forms of inflation are wage inflation, price inflation, asset inflation, and import inflation, to name a few.
As our CEO and CIO Scott Colyer detailed last week in his Viewpoints, commodities are looking to us to be a once-in-a-generational buy. Since they have been left for dead by many investors but the demand for the base commodity product coupled with no new increases in many of the supplies of these base commodities (mitigated by the use of technology to generate these products) leaves us at the base level of a super cycle for commodities.
With expectations so benign for inflation and recent history-given examples of spikes in inflation that are well above the Federal Reserves target level, we see inflation as the pivot point.
CRN: 2020-1202-8785 R
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.
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