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Inflation - How Big a Risk Is It?

The exponential rise in the national debt since COVID began by the tune of more than $3.8 Trillion of stimulus monies was inevitably going to lead to a wave of hard asset inflation as well as consumer inflation. The only question was "how much"?

In the last couple of days, the markets woke up to the fact that inflation might be worse than the federal reserve predicted. The CPI (Consumer Price Index) numbers released for April 2021 rose 0.8% versus an expected rise of 0.2% month over month. Should we be alarmed and worried? In the short term, the answer is "not really". If you have been tracking first quarter earnings calls, you will have heard many CEO's describing how tight supply chains are right now. Higher costs of raw material inputs are being passed onto the consumer. As COVID restrictions ease and consumer demand for goods and services rise alongside tight supply chains operating on "just in time" demand cycles, the natural consequence of greater demand and tight supplies is higher price increases.

It is difficult to say how inflation numbers will fare over the coming months as it will take time for supply chains to re-calibrate and meet rising demand.  However, as this occurrs, inflation numbers will likely decrease as supply increases. Overall, however, we expect the inflation trend to show up as net higher consumer prices across most hard and soft asset categories, compared to before the pandemic.

While the extent of the recent rise in the CPI may have caught Wall Street off guard, it was more than reasonable to bake this scenario in for April. The reaction is over done and leading to a much needed correction or pause. We think investors should be more concerned about the high company valuations which now exceed dot com era valuations. Investors should be asking whether valuations across different industry, service and technology can be justified and sustained. While some sectors are undervalued due to the demand-hit from COVID and will rise alongside the recovery in consumer mobility and spending, others are at historic highs compared to previous dot com highs.

The trifecta of massive stimulus, the re-opening of the economy as COVID restrictions are eased and low interest rates are fuelling an unprecedented cash infusion into hard assets unlike anything we have seen. How long will it last? It is of course impossible to say, but this powerful trifecta could continue to add fuel for market appreciation for many months, even years to come. It is hard to quantify the impact of trillions of dollars of net influx into the economy but this will remain a powerful driving force for some time to come.

Long term, the ballooning debt will have to be addressed. To this point in time politicians have always found good reasons for kicking the can down the road. Curbing expenditures and balancing the books is not the prescription that makes politicians popular with their constituents. And so the can will continually be kicked down the road until it can't.

Stanley Drukenmiller recently commented on this matter...

“Future fiscal burdens will put the kind of political pressure on the central bank that hasn’t been seen in decades. The federal government has added 30% of GDP in extra fiscal deficits in only two years, right as the baby-boomer retirement wave is beginning to accelerate. The Congressional Budget Office projects that in 20 years almost 30% of all yearly fiscal revenues will have to be used solely to pay back interests on government debt, up from a current level of 8%. More taxes simply won’t be enough to bridge the gap, so pressures to monetize the deficit will inevitably rise over the years.”

We think there is more fuel in the tank to grow the current asset bubble to unsustainable heights. Inflation is here to stay. The only question is: "how much?". At some point the narrative will change and the markets will follow. We just dont know when that point will arrive, but that it will surely come. Stay tuned!

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