Inflation - The uninvited guest who came to stay

Chart of the week

The chart shows the annual change in the consumer price index in the US over one year, i.e. inflation. This is distinguished into a main value (headline, red) which includes all goods and a base value (core, blue) which excludes food and oil prices, which are often more volatile.

Why it matters:

Most market participants assume that the high levels of 5% inflation came only because of a base effect after the pandemic and will quickly fall back to 2%. Central banks have also reassured all investors with the same arguments. There are now increasing signs that this will actually not be the case. The level of inflation has a major impact on both the central bank policy and on the stock markets. On October 13, the value for September will be published. If it exceeds 4%, it will have a very negative impact on the stock and bond markets.

Inflation - the uninvited guest that came to stay.

Inflation can rise due to the following three reasons:

- Inflation due to demand pull

- Inflation due to cost pressures

- Expected inflation

Inflation due to demand pull 

Very high demand results in long delivery times. Customers who urgently need goods or intermediate products for the production of other goods are willing to pay more. Suppliers increase their prices. 

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The chart shows data from a survey of purchasing managers in the USA. The survey is often very telling about the further development of the companies. Let's focus first on the line of delivery times (green). After an initial shock post Covid crisis, they reduced delivery times again and everyone thought the problem had been eliminated. Delivery times have now gone back up very sharply. This will have a very negative impact on most companies' Christmas & holiday business. 

New orders have decreased slightly but still remain high. Unfortunately, the delivery problems are not slowing down. Further increased inflation figures are very likely from this sector.

Inflation due to cost pressure

 Due to the pandemic, almost all international supply chains went into complete disarray. Whenever it seems that supply chains are returning to normal, there is a bottleneck somewhere again. Container congestion in Asia, blockade of the Suez Canal, ship congestion off American ports, power outages in China. etc.

The chart shows transportation costs by ship since 2005. These costs continue to increase sharply. A clear signal that supply chains are still completely out of whack and still need time to return to normal.

What is positive here is that the prices of many commodities have dropped by 10-30% since mid-year. However, it is currently difficult to assess whether this is sufficient enough to compensate for the cost increase in transportation.

Also the graph above under the aspect of demand pull shows that input prices (orange line) are still very high and not decreasing. Cost pressures persist and will not lead to a strong slowdown in inflation for the time being.

Expected inflation

This is the third and most difficult inflation driver to analyze. It is all about the psychological behavior of the population. As long as everyone thinks that we will have high inflation for only 1-2 months, workers will not demand higher wages. But if their expectations change, they will start to make demands, which then fuels inflation even more. A spiral is set in motion that is difficult to stop. More inflation brings higher inflation expectations, which brings higher inflation....

Conclusion:

 Two of the three inflation drivers are still strong and hardly weakening. We therefore fear that inflation figures will be higher than generally expected. If inflation does not come down now as expected, this could lead to the third inflation driver (expected inflation) beginning a spiral that is difficult to stop.
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Outlook for company earnings releases for Q3 2021.
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Starting next week, the first companies will announce third quarter earnings. What do you have to watch out for?

For analysts, it negatively impacts their reputations if the estimates for the profits of a company deviate too much from the published profits. Especially if the analysts estimate profits that are much higher than reality. For this reason, most analysts go over the books 2-3 weeks before the start of the reporting season and adjust their estimates.

The chart shows the Citybank Earnings Revision Index. It currently shows that many analysts have sharply reduced their estimates in recent weeks. This was one of the reasons for the Risk-OFF phase described in last week's report. This suggests that we won’t witness negative disappointments.
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One possible way to look at whether companies are valued too high or too low is to compare the Earnings Yield to the yield on the 10 year government bond. The Earnings Yield is calculated by dividing the earnings of the stock by the stock price. The chart shows that most companies are slightly more expensive than the long-term average, but are far from being overvalued.
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From the two aspects described, we can therefore expect a rather quiet earnings season.

When announcing earnings for the second quarter of 2021, nearly 50% of companies complained about higher costs. This is where it will be important to watch if more or fewer firms see the same problem for the upcoming quarter. This is where the biggest danger lies with earnings announcements. If too many companies warn of new dangers here, stock prices could correct downward.