Is inflation here to stay? Let’s consider the labour market.
Presently, there has been pronounced shift in investment sentiment away from growth to value stocks, with high growth high PE or no PE stocks copping a beating and value sectors– financials, energy and basic materials outperforming. The catalyst for this shift in investment flows has been rising interest rates and mounting inflationary pressures that have shifted Fed policy to a more hawkish or tighter monetary policy stance. Inflationary pressures are to a large degree a result of supply constraints, however stimulatory monetary and fiscal policies have also supported demand and the combination of both results in higher prices for goods and services. We believe a sustained shift from growth to value stocks will ultimately be determined by the where inflation is heading. We believe current high inflation rates are to a large degree an outcome of the pandemic and that an end to the pandemic will restore labour mobility and availability which will have deflationary consequences. Our portfolio bias remains weighted to ETFs exposed to structural attractive growth industries over the long term.
US INFLATION RATE
A big question is, how aggressive will the Federal Reserve be in terms of policy tightening? However, we think it is important to focus on the root cause of higher interest rates, being a rise in inflation to levels not seen in 40 years. In the latest US inflation data, energy was the biggest contributor to the gain in November, rising 29.3% with gasoline prices surging 49.6%. However, all categories within the data accelerated including food, shelter and used cars – up 37%. Much the inflationary pressure around the world is attributed to supply chain constraints (caused by the pandemic) and we envisage that at some point these constraints will unwind – possibly in 2022. Rising labour costs and lack of labour availability are direct consequences of the spread of virus. For example, the shipping, retailing, transport and meat processing industries have all been adversely affected by labour shortages through-out the pandemic. Brad Banducci, CEO of Woolworths said that the supermarket’s distribution centres had experienced absenteeism of between 20% and 40% as a direct consequence of Omicron.
The free movement of people (labour) and migration, not only places downward pressure on wages but also lifts productivity*. Thus, the overall health and mobility of the labour force are critical factors in restoring the efficiency of the supply chain to pre-pandemic levels.
US WAGES GROWTH
Wages grew 9.8% in the US in October 2021 compared to an average of about 4.5% for the last 10 years.
Labour mobility… inbound travel has collapsed.
So how badly has the pandemic hit the mobility of people to move around the world? Let’s look at a key indicator – inbound travel. In Australia, inbound travel has dropped from 9.5m people arriving annually in January 2020 to just 168,390 in October 2021.
INBOUND TRAVEL TO AUSTRALIA
We note that Australia relies heavily on foreign labour - over 850,000 migrants, backpackers, overseas students a year add to our labour force each year. These people work in many industries, such as travel, restaurants, agriculture and mining.
In the US the number of inbound travelers has fallen from around 70 million annual rate to 20 million arrivals. The US relies heavily on itinerant workers in many industries. And if we look globally the fall in inbound arrivals have fallen by around 70% or more. Indeed, one of the reasons we believe unemployment rates are so low is the lack of available labour and typically low unemployment rates are negatively correlated inflation. Australia and the US UE rates are just 4.1% and 3.9% respectively. Subsequently a rebound on people mobility should effect a dampening on wages growth and inflation.
AUSTRALIA UNEMPLOYMENT AND INFLATION RATES
INTERNATIONAL TOURIST TRAVEL
Oral antivirals are coming….can these drugs change the game?
We believe one of the single most underappreciated developments in the fight against C-19 variants has been the breakthrough in oral antivirals developed by Merck (molnupiravir) and Pfizer (Paxlovid). These new drugs, now approved by the FDA have been shown to reduce hospitalization and death rates in unvaccinated people by between 30% and 90%. We believe these antivirals could enable people to travel more freely as they can easily be carried by travellers. Additionally, businesses should expect to see staff availability rise as sick days or isolation rates fall. Importantly, antivirals will also enable unvaccinated people to live and work with the virus.
We believe that much of the global inflationary pressures are pandemic induced and thus an end to the pandemic will ultimately result in these pressures unwinding. Vaccines are important weapons in the fight against the pandemic, however oral antivirals and abundant (free) rapid antigen tests are needed to allow people (labour) to move freely.
We have positioned our portfolio of ETFs to benefit from the potential upside in the travel sector. A step change in health related spending given government and private industries is also reflected on our investment bias towards healthcare stocks.