“What a difference a year makes,” might seem to be a bit cheeky of a cliché to describe the passage of ‘The Year That Seemed to Last a Lifetime’ for all of humanity, however, here we are: 14 months after the global shutdown, 1.3 billion doses of vaccine have now been administered as more and more people are becoming protected from the virus and thankfully, we are finally starting to see some nascent returns to normalcy in many parts of our daily lives. This grim and somber fight against Covid-19 continues to rage on and ravage many parts of the world, and we remain hopeful that collaborative international efforts can help to turn the tides in those hard-hit areas.
While the spectacular economic and market declines of 2020 are all images we would like to forget, their rebound and reversals as we move back into cyclical expansion are just as awe-inspiring.
Figure 1: What Recession? Year Over Year Global and Regional GDP Changes
Source: Blackstone
Figure 2: Don’t Blink…Leading Economic Indicators Recover in Record Time
Source: Blackstone
We wrote last quarter that the massive fiscal and monetary stimulus would boost consumer savings, spending and confidence, and three months later, the data proves it out. As a consumption-driven economy (68% of our GDP), these trends bode well for continued cyclical economic expansion as the uneven, yet steady reopening matures.
Figure 3: Piggy Banks Topped Off…Personal Incomes Being Driven by Jobs, Not Just Transfer Payments
Source: Cornerstone Macro
In addition to traditional measures of consumer spending, alternate methods of measuring consumer activity such as foot traffic are helpful indications that life is starting to return to normal. If you feel like you have been waiting in longer lines, or that airports, restaurants and stores are more crowded recently, its not your imagination.
Figure 4: Revenge Travel…Weekly Foot Traffic Back to 2019 Levels
**CSM Recovery Index – Sum of weekly Hotel, Casino, Recreation, Dining, Fitness and Department Store patrons, nationwide
Source: Cornerstone Macro
Importantly, business spending is back on the rise as well. While this segment accounts for a smaller proportion of our economy (13%), it is a critical component to ensure the durability of this expansionary cycle as business spending generally creates more jobs and improves overall productivity.
Figure 5: Get Back to Work! Q1 and Forecasted Capital Expenditures Show Strong Investment
Source: Cornerstone Macro
With a surging economy and significant stimulus injected into the system, concerns naturally shift towards inflation. Clearly there are pockets of inflation that are pushing through our economy as pent-up demand has created a major drawdown on inventories and resources, while supply chains are not yet fully back online. Cultural shifts in mobility and workplace are also creating outsized price pressures for materials and housing stock across the country, particularly in formerly sleepy rural towns, much to the chagrin of longer-term residents.
While we were a bit surprised by the sharp rise in nominal yields in Q1, decomposing the catalysts of that rate move can be attributed to stronger future economic growth expectations (which is good) versus rising inflation expectations (which is bad). In fact, looking at real rates (nominal interest rates minus inflation) we see rates are still firmly negative. While eventually this condition will resolve itself, we expect we still have some time before it does.
Figure 6: Don’t Be So Negative…Real Rates Still Below Zero
Source: Blackstone
Arguably the most important part of inflation to watch is wage inflation. Too much or too rapid of wage inflation hits profit margins, reduces earnings and ultimately drives up prices as more dollars are chasing scarce goods and services. As the labor markets return back towards normalcy, we are keeping our eye on wage inflation as measured through the employment cost index (ECI). Historically, when unemployment declines south of 5%, ECI starts to rise.
While the unemployment rate continues its decline, it continues to be offset by more people returning to the workforce, as participation rates are slowly on the rise again.
Figure 7: What We’re Watching (and We Suspect The Fed is too)…Labor Costs
Source: Cornerstone Macro
Rising labor force participation rates increase the supply of the labor pool and help to contain runaway wage costs. Additionally, continual improvements in technology, innovation and automation help to boost productivity, which all work to strongly counteract wage inflation pressures.
Figure 8: Disinflationary: Technology and Innovation Continue to Drive Productivity and Profits
Source: Cornerstone Macro
As the economy has now entered a new phase, we have continued to make adjustments in client portfolios, increasing exposure to smaller and more cyclical companies that should benefit from the reopening trend. We have also added additional exposure to real assets which helps to protect portfolios against burgeoning inflationary pressures. Our secular allocation to Innovation remains broadly represented throughout our equity profile and we continue to present timely and compelling Private Capital opportunities to our clients who are seeking differentiated sources of return and income.
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We continue to experience steady and stable growth and we are grateful that everyone on our team is healthy and safe. We sincerely hope that you and your loved ones are keeping well and please do not hesitate to contact us if you have any questions or if we can be of further assistance.
