16May
Bottlenecks and inflation

Whoever gets inflation right will hold the key to the winning asset pick.

Euro coins.

Everyone talks about bottlenecks, but no one explains why they have occurred, much less “bottlenecks” to say how long they can last.

But you have to get wet, because it is a fundamental question when it comes to predicting what the level of inflation may be in the medium term, which is the mother of all battles when it comes to investing now in the financial markets. Whoever gets inflation right will hold the key to the winning asset pick, which is what defines the result of a portfolio of funds. Much more than the selection of managers.

If inflation is going to remain high for a long time, certain assets will perform better. Some will even greatly benefit from your presence. If we go back to the pre-pandemic situation, others will work just fine. The difference can be abysmal.

I will explain bottlenecks with an example: imagine you have a business that has been closed during the lockdown. Of course, he does not have a warehouse full of products, since he does not know what the demand will be when the reopening takes place. And more when the majority of economists, analysts, tweeters and influencers they tell him that after the pandemic the real crisis will come (forgetting that we have indebted the next generations up to their eyebrows precisely to avoid it and that the central banks have watered the money system as an antidote).

In the case of a small business, it is easy to adapt if you see that people go out to the streets willing to spend and consume. But imagine when this happens in a mining operation in an emerging country -or directly underdeveloped- that has had to close due to Covid. And the vaccines haven’t even arrived yet. A mining operation is not started just like that. And less in those circumstances. The manufacturing rate of a large factory is not doubled, nor are ships chartered that have been stranded for months, etc., etc.

Whoever gets inflation right will have the key to finding the winning asset selection, which is what defines the result of a portfolio of funds

Also, it is a vicious circle. When merchants or large car manufacturers -or computers, or whatever- see that there are supply problems, they get nervous and buy anywhere and at any price. Not just anyone, but are willing to pay much more. They will see later if they pass it on to the client. The fact is that a certain panic is generated at not being able to meet the demand. And so we have the bottleneck and the inflation it generates.

Clarified this, let’s go with the predictions. The first is that just as the law of supply and demand works to increase prices, it also works to balance supply and demand. In a market economy, when someone wants something and is willing to pay for it, the offer ends up arising. Another thing is the price.

When will equilibrium occur? It is impossible to predict. It is necessary to follow the evolution of the prices of the different components and the advanced economic indicators that affect these products. For example, see how the traffic jams are going in the North American, Chinese or European ports. It is about monitoring the situation –and the prices– of the production and distribution chain in each of its links.

Although there will be a break-even point, current energy prices are the result of a structural decision that will take a long time and cost money

This goes for many things, not so much for energy prices. Although there will be a balance point, current energy prices are the result of a structural decision – the energy transition – that will take a long time and cost money.

What seems clear is that even if we solve the bottlenecks, inflation will be much higher than it was before the pandemic. Although the growth generated for the next two years is of somewhat artificial origin, the result of the mix of monetary and economic stimulus, it will be significant growth.

It does not have to imply high inflation, we will see, but wage pressure is more evident every day, which will be added to the cost of the energy transition. In addition, inflation has a lot to do with sociology: once it is inserted into the minds of consumers, it feeds back.

For investors the conclusion is easy: in the coming months the issue of inflation will continue to be the key to the evolution of the markets and we must know how to handle it. You have to know which assets and sectors benefit from each level of inflation. Because in this the nuances are important: little is not the same as a lot or a lot of inflation.

And in all inflationary scenarios – little, a lot or half a pensioner – you have to avoid bonds and medium- and long-term fixed-income funds like the plague. I said it on May 4 from these same pages, and you see. We call that strategy “The Great Rotation”. Now I insist on it, because the rotation has not ended. It’s probably just started.

*** Víctor Alvargonzález is an independent financial advisor and founding partner of Nextep Finance

16Mar
Take your pick: stagnation or inflation, but not both.

In the more than ten-year drought of financial misery, many analysts and advisers have grasped at inflation like straws.

Euro bills.

For ten years now, the way to attract attention in the markets is to announce some kind of financial misfortune. A crisis, a bursting bubble, or any other scary issue that generates followers or clients looking for protection. Although the funniest thing is that, in the end, it was neither a financial crisis nor a bursting bubble that caused Armageddon, but a virus from China.

So, with a more than ten-year drought of financial misery going on, many analysts and advisers have seized on the inflation like a burning nail, assuming, from the outset, that inflation is always bad for the economy or the stock market, when history shows that it depends on the level of inflation.

And then, taking advantage of the problem posed by the bottlenecks of the restart of activity, they have included in the “pack” the economic stagnation. Stagnation plus inflation: what can be scarier? If that doesn’t make all potential clients seek your protection, nothing will.

So, if you allow me to be politically incorrect, I will tell you that, at least on this occasion, it seems difficult to me that both horsemen of the apocalypse coincide. The one of stagnation is neither there nor is it expected. The one with inflation, yes, but he will probably stay as a rider for good, without reaching the level of horseman of the apocalypse.

Of course I agree that inflation is going to be higher than it was before the pandemic. I said it a long time ago: the closest thing to getting out of a pandemic and a global lockdown is getting out of a war. And the two world wars have come out with more inflation. If we add to this that never has so much money been injected into the system and that the stimulus plans make the Marshall Plan, it does not take a genius to realize that inflation will be higher. Probably quite higher.

The closest thing to getting out of a pandemic and a global lockdown is getting out of a war. And the two world wars have come out with more inflation

But those who trust that we will return to 70s or 80s-type inflation levels make the same mistake as when they spoke of the “Chinese Lehman”: they are making a comparison that is based more on desire than reality. Of course there are inflationary elements. And that we are going to have a serious problem with energy, since the cost of the energy transition has not been properly assessed. But the weight of energy in inflation today is not comparable to the 1970s. Then it was 9% and today it is 4% (US PCE)

But, above all, they forget that we are still in the middle of the industrial revolution, in this case the digital one. I don’t have space to explain why, but believe me: all industrial revolutions have been disinflationary. And this is no exception. The digital revolution will act as a buffer in the prices of services.

Of course there will be salary pressure, we are already seeing it. But precisely that helps to avoid the arrival of the other horseman of the apocalypse, the one of stagnation. People having money in their pockets is good for growth. And since we are talking about growth: although it will be artificial and the result of monetary and economic stimulus, there will be growth.

The predictions of organizations with a good predictive history – that is, I do not include the IMF – speak of global growth for the coming year of more than 5% and around 4% in 2023. But, even if it were 3% – that would already be wrong -: it cannot be called stagnation.

Those of us who advise investors and savers must prioritize objectivity and realism over the search for the “like” or the “retweet”

In the end reality spoils a good tweet. And the reality is that it seems difficult for the doomsayers to achieve the carom of stagnation plus high inflation.

Those of us who advise investors and savers must prioritize objectivity and realism over the search for the “like” or the “retweet”. And the first and fundamental thing when defining an investment strategy is precisely to be clear about the macroeconomic picture. And for that you have to be realistic.

Those who anticipate stagflation are telling investors the same thing they told them when they were told about crises and bubbles: avoid equities. But, given the record rise in stock markets in the last 10 years – and especially in the last 20 months – think twice before following that advice.

Remember that only high and persistent inflation is bad for equities. And for the record, as independent advisors, we do not charge more for recommending equity funds than for recommending funds that invest in gold or leave the money in a checking account. Right or wrong, our advice is totally free of conflict of interest.

*** Víctor Alvargonzález is an independent financial advisor and founding partner of Nextep Finance

30Jan
Inflation and bottle half full or half empty

There are elements to think that the rise in prices will last, which would force an increase in interest rates in the euro zone sooner than expected.

Inflation and bottle half full or half empty

Until a few months ago, high inflation rates seemed like history in developed countries. However, part of the response to the pandemic, in my correct opinion, was the massive purchases of assets, especially public debt, by the Central Banks. This meant massively injecting money into the financial system, which allowed states to sustain family incomes, financing itself at the lowest interest rates in history. The counterpart was that when the activity resumed, this money was going to put greater pressure on demand.

As we are seeing, the supply, given that there are still restrictions in many parts of the world, is not being able to supply the demand. This has led to a spike in inflation. But as at the same time, the economy is recovering, we have economic growth.

If we leave the analysis here, the only thing there is is a time lag. And this is the vision of the half-full bottle, for example, of the chief economist of the IMF, Gita Gopinath, which indicates that we do not have stagflation because world economic growth (yes, and also in Europe and Spain) is robust. If this were all, in a few months the economic supply should be restored and return to low inflation.

But, we have two more factors to take into account, which darken the picture. The first of them is him energy pricewhat is a shock full-fledged offer. According to the latest data from the INE, for the consumer, gasoline has risen by 22%, diesel by 23% and electricity by 44%. But the cost has gone up quite a bit. These data are after taxes, and special taxes, which were more than half of the final price of oil derivatives, have remained constant.

In the case of electricity, taxes and charges passed on to the consumer have been substantially reduced, and even so, the bill has increased a lot. If we go to natural gas, the wholesale price is the highest in history.

All this creates a rise in production and transport costs (the cost of freight has multiplied in some cases by 10) which is causing price increases in industrial products and even factory closures, that is, a reduction in supply. And all this happens before winter arrives in the northern hemisphere, which is the time of maximum demand for electricity and especially natural gas for heating.

In addition, the pandemic has produced structural damage to the economy and businesses. For example, if last year, gas and oil were at historical lows, many companies that produced it, and that were also heavily indebted, such as fracking, went bankrupt. This has meant that there is no productive capacity when demand increases. And it is one of the reasons behind the rise in the price of natural gas.

In addition, there are cases of simple error: the Taiwanese decision that they were not going to sue more chips in 2020 has led to a global semiconductor shortage in 2021 that is paralyzing car factories due to lack of components, which are also rising in price. Paraphrasing to Keynesenergy and commodity markets can remain in a state of madness much longer than many companies can remain solvent.

The reality is that we have demand inflation and supply inflation. And at the moment we have growth, but it will lose strength

The truth is that we have demand inflation and supply inflation. And at the moment we have economic growth, but growth will lose strength, if it does not do so sooner, when we recover the economic activity prior to the Pandemic. This is not a pessimistic scenario, but rather a relatively optimistic path without losing sight of reality. The pessimistic path would be to think about what would happen if new variants of the Covid arise that force reset restrictions.

In reality, that inflation is here to stay, as the chief economist of the World Bank maintains, for example, Carmen ReinhartIt depends on two factors. Firstly, that energy prices moderate at some point. Everyone assumes that this will not happen until March at least. But from there, if global demand for gas continues to increase, because, for example, China wants to meet its climate commitments and cuts coal, replacing it with gas, to produce electricity, then energy prices will remain high. If this goes on for a long time it is absolutely inevitable that the increase in energy prices will end up being transferred to all products and services.

In second place, if wages go up, to compensate for the price increases, we will have “second round effects” and inflation will settle at a higher level than before the pandemic. This will happen more likely in the United States than in Europe, since the level of unemployment is lower and there are more and more jobs that companies cannot fill.

With all this scenery, the Federal Reserve is quite likely to have to withdraw stimulus sooner than expected. In fact, the governor of the Bank of England has already threatened to raise interest rates.

Obviously, if interest rates rise in the United States, capital from the rest of the world will take refuge there, which will increase the value of the dollar against other currencies. Bearing in mind that oil, for example, is paid for in dollars, a devaluation of the euro, especially against the dollar, will lead to more expensive imports, and consequently more inflation.

All this scenario could lead us to higher inflation and interest rates in the euro zone sooner than we think, which is not good news for growth: the bottle could be half empty.

To avoid the worst economic effects of a supply shock Structural reforms are needed to increase productivity. If we only had a temporary mismatch between supply and demand, everything would probably be easier. In any case, unfortunately, the negative economic effects of the pandemic are worse and longer lasting than we would like. Fortunately, the worst was behind us.

*** Francisco de la Torre Díaz is an economist and tax inspector.