Three Key Thoughts:

1. Party On!

2. Bond Bulls vs Inflation Data

3. China: The CCP at 100

Party On!

A little more than 30 years ago, Wayne Campbell of Aurora, Illinois introduced us to Wayne’s World, a self-produced live TV show broadcast from Wayne’s basement on the local public access channel. At Wayne’s side was his best friend, Garth. Wayne was of course played by Mike Myers and Garth was played by Dana Carvey. Their misadventures and celebrity guests were the stuff of regular spots on Saturday Night Live for several years. The two coined several catch phrases of the 1990s but perhaps none so long lasting as “Party On, Wayne” and the retort “Party On, Garth.”

Despite not quite reaching the Biden Administration’s 70% vaccination goal, the economy seems to be very much in “party on” mode. People are traveling, going out to eat, attending live concerts and, yes, even thinking about returning to the office. Highways and airports are packed, restaurants are booked up and concert venues and sports stadiums have capacity crowds. And that return to the office, well, maybe we need to think about that one a bit more.

Jobs are plentiful as businesses try to staff up to meet resurgent demand. And potential employees, emboldened by the expectation of continued labor shortages, are asking for higher wages and more flexibility to work where and when they want. Similarly, great demand and short supply has the housing market making new highs, seemingly by the day. Oil prices have also soared past $70 a barrel, more than tripling off of the lows of last year. For many months, lumber prices were the poster children for post-Covid inflation as enormous demand from renovators and builders met supply limited by Covid-imposed production shutdowns.

While we have started to see these pressures appear in inflation statistics, we don’t yet know how permanent or pervasive they will be. It seems likely to us that home price increases and wage pressures may be sticky for a while as we can’t “produce” more homes or workers quickly. On the other hand, we think it is likely that oil and other commodity prices will level out and even decline as supply catches up to and then exceeds demand. We believe the same thing may be true with respect to other price increases induced by supply chain problems (think computer chips for cars and home appliances, for examples).

Bond Bulls vs Inflation Statistics

Not surprisingly, recent reports on retail and wholesale inflation show the sharpest increases in decades. We fully expect this to continue for at least several months as both the “stickier” elements of inflation and the temporary inflation drivers push prices up across the board. The Federal Reserve has indicated it is willing to let inflation run “hotter” than its long-term target of 2% for some undefined period of time, before beginning to roll back its bond buying and start raising short term interest rates. We expect that “undefined period” is likely to get shorter as the inflation reports come in over the coming months.

However, a very odd thing has happened in the bond markets. You would usually expect that this type of inflation outlook would drive longer term bond yields higher, perhaps significantly so. But let’s trace the recent roller coaster ride of the yield on the 10 year Treasury bond. Starting at about 1.90% at the beginning of 2020, it dropped to about 0.53% in August of 2020, before starting a gradual climb back. That climb continued into March of 2021, when the yield peaked at about 1.75%, nearly a complete round trip. However, since then the yield has plummeted about 45 basis points, reaching 1.30% at this writing, even as the inflation numbers are ramping up.

Part of this strange behavior is the Fed’s continuous buying of bonds. But that has been going on since the depths of the pandemic so it isn’t new. Clearly a good many bond investors believe that inflation will cool off, dramatically so, in the not-too-distant future. There is a case to be made that today’s supply chain induced shortages will lead to tomorrow’s glut of goods for which demand has been sated. Or a new Covid variant could stymie the reopening. A third outcome is that bond yields will have to jump quickly to adjust to a new era of inflation. Nobody knows how this will turn out. Stay tuned!

China: The CCP at 100

Marking the celebration of the 100th anniversary of Chinese Communist Party, the Xi regime combined tough talk of China’s inexorable rise with initiatives designed to foster self-reliance and innovation. Interestingly, these initiatives have been paired with continued efforts to put the CCP in full control of economic and personal freedoms. The Party has already demonstrated its power by reining in some of China’s most successful companies under the guise of “protecting” Chinese citizens from the loss of control over personal data. (For a government that has long made private citizens’ data its own domain, the irony in that statement is stunning!). The latest target is companies that wish to list their shares outside of mainland China. In the wake of the harsh limits placed on Hong Kong citizens, these actions may seem mild but they are cause for concern about China’s interest and willingness to engage with the rest of the world.

More puzzling is trying to make the link between the innovation that China sorely needs to keep its growth engine alive and its desire to generate this internally, while controlling the lives of its citizenry. As Americans, we tend to link economic creativity and growth with personal freedom. China is making a big bet that the CCP can drive the innovation it needs while limiting personal freedom. It hasn’t been done before. Then again, modern China has done lots of things in the last 30 years that few thought they could.

Investment Implications

While new Covid variants are a risk to reopening, we believe that the combination of vaccination success and massive government stimulus will continue to win out. This is mostly good news for investors. We remain cautious that other government policies – particularly on taxes and regulation – will likely move against investors. As a result, we are keeping asset allocations close to long term targets, with sufficient cash available to take advantage of short-term setbacks.