2021 Third Quarter Market Review

By Michael Carlisle, Vice President &
Investment Committee Chair

As the third quarter ends, we invoke the Bard’s famous question as it relates to inflation in the US economy.  Inflation has been the topic du jour in 2021 for anyone following economic and market news.  Is it “transitory” or more “endemic”?  Why do we care?  Answer, because maintaining price stability is one of two core mandates of the Federal Reserve, thus inflation is an ever-present influence on Fed policy and by extension, asset prices.  

August consumer prices (CPI) rose at an annual rate of 3.3%—well above the Fed’s 2% target.  Covid-Delta has impacted economic activity during Q3—particularity travel and leisure—inducing price declines in such items as airfares and hotel rooms.  As Covid gradually recedes these prices will likely rise, giving credence to the view that inflation will not be as transitory as some would have us believe.

Another major influence on the rate of inflation is the cost of housing.  Housing rents (comprising about 30% of CPI) are currently significantly understated and are likely to accelerate sharply in the years ahead.  Ultimately, it is important to remember that inflation is still a monetary phenomenon and the M2 measure of money supply is up approximately 33% since Q1 2020.  Eventually this will translate into a rise in overall spending and augur for higher inflation.  Supply chain disruptions, rising freight costs, and worker shortages leading to higher labor costs, all conspire to support the higher-for-longer view of inflation.

In the real world, transitory does not mean inconsequential!  Let’s assume the Fed’s 2% inflation target is achieved.  At this rate, in 10 years prices would be approximately 22% higher.  It is not likely worker wages rise to match that rate of increase, and the loss of purchasing power for those on fixed incomes would be significant.  Needless to say, if inflation were to trend above 2% the loss of purchasing power would be even greater.   

To compound the problem, measuring inflation is more art than science.  Based on our spending patterns, we all feel inflation differently.  Simply put, it is difficult to accurately measure inflation.  Policy makers may think it is not a problem when it actually is, leading to errors that can trigger recessions.  The nature and scope of this publication does not allow for a thoroughgoing analysis of all the components and processes of how inflation is determined and its different measures, i.e., CPI, PPI and PCE.  Suffice it to say, the various measures of inflation command the attention of policy makers and investors the world over.  So, the debate as to the level and duration of inflation will continue for some time to come.       

To view or print our complete Q3 newsletter, click here.