What To Think About Inflation?

 The Turkey Conundrum

 

A few days ago, many of us either had the pleasure of hosting or the gift of attending a Thanksgiving get together. We caught up with friends and family, laughed, maybe watched a little football, and probably had a front-row ticket to a heated debate. At some point though we all gathered around a table and tried to figure out how we could find an angle to get the drumstick, and until science figures out how to make a turkey with more than two drumsticks, there will always be a large demand chasing a limited supply.

 

This scenario is one of the main reasons that we see quick increases in inflation numbers. There is a large amount of dollars chasing after a limited supply of goods and services. Inflation numbers are most often quoted as a year-over-year number comparing the cost of a basket of goods last year to the cost of the same basket of goods this year, and as we know from the discussion around the Thanksgiving table, last year was anything but normal.

 

In fact, the most apt parallel that can be drawn to inflation today in our opinion is what the U.S. experienced after World War II.  We had soldiers returning home, industries retooling back to providing goods for the consumer instead of the war effort, a housing boom, and a high demand for consumer goods and services. After two to three years the supply and demand sides of the inflation equation normalized and even flirted with deflation as supply overshot demand.

 So, What’s Transitory and What’s Not?

 We believe that most of the inflation we are seeing now will be transitory. There are some areas that might be a little “stickier” like finished products and services. Raw (think oil) and semi-finished goods (think lumber) will tend to be more transitory than inflation we see in finished products and services (houses, vehicles, airfares, consumer goods).

 Oil, for example, traded negative on the exchanges early on during the pandemic as there was an oversupply from producers and no one to take physical delivery of the crude oil.  Oil producers scaled back production, laid-off workers, and idled rigs as production became unprofitable. As the world got closer to normalcy and demand picked up, there was a lagging supply of oil and prices increased. Eventually, production will surpass demand as producers overproduce and we will see prices decrease and reach an equilibrium again.

 These stories will play out in countless industries as disruptions get corrected and bottlenecks cleared. It’s important to remember that after these severe disruptions that global supply chains handle like a Freightliner and not a Formula 1 car. They can neither stop or start on a dime, but given enough road and time, they are efficient. We believe that with time and a prudent hand at the wheel (Federal Reserve policy) that inflation will normalize in the future.