Inflation is a persistent issue coming out of the COVID lockdown economy and continues to create a great amount of confusion for the retail investor space. Many retail traders don't know what it means or how to respond. More specifically, many are having trouble with tailoring their portfolios to either avoid risk or take advantage of inflationary circumstances. I aim to somewhat remedy this. I hope the pointers below will help you better understand the inflationary environment and identify economically favorable industries/sectors. This is not the end all or be all and I welcome your observations and comments on what I could have missed. Enjoy this and lets make some money taking advantage of these once in a lifetime economic circumstances.
- Inflations is Measured by a Change in Rate: Inflation doesn't usually go down. The RATE of inflation goes up or down, but inflation itself is persistent. This is by design. Could you imagine what would happen to the economy if you knew that your dollar would be worth more tomorrow than it is today? Spending on goods other than necessities would come to a very dramatic reduction. So it is important to understand that what we are looking at is the CHANGE IN RATE of inflation. There is no deflation!! Deflation is 1000x worse for the economy than inflation. So do not expect deflation. The Fed simply will not allow it. Nor should they!
- Current Inflation is Largely a Result of too Much Demand: During the COVID lock downs many businesses were forced to grind their operations to a halt. Remember food, toilet paper, & other essentials flying off the shelves? Indeed many grocery stores were limiting the amount of water you could buy. It only stands to reason that when you force businesses to close down you create a situation where the goods that people demand are not being replaced by a steady supply. So what happens as the economy opens back up? Suddenly those same businesses have reduced inventories, they need to hire back workers, they need to order new supplies, & they need to meet an increased demand as a result of some competitors closing their doors for good. Now the quantity of goods demanded well exceeds the quantity of goods supplied … on all fronts. Reopening firms are competing against other reopening firms for the same raw materials, supplies, resources, shipping, etc. They are also competing for the same labor pool. Remember that goods & services in times of extreme scarcity go to the highest bidder.
- Secondary & Tertiary Effects of too Much Demand (Or too Little Supply): Below you will find the inflationary issues we find ourselves in as a result of increased demand and limited supply. Below each topic you will also find some examples of how to profit from each. You will also receive some examples of secondary and tertiary effects of each.
- Supply Chain Bottlenecks: First and foremost in the news are the supply chain bottlenecks. We've all seen the ships floating off the Port of Los Angeles, or the very long line of trucks waiting to pick up freight from the ports. The United States & Europe have but a limited number of ports and they're taking on all the supplies that firms ordered as the economy opened back up. Making things worse … its holiday shopping season. So cost of shipping dry bulk overseas is not just rising as a result of increased demand, but as a result of the fact that it costs money to have all these carriers waiting weeks to offload their goods. Making matters worse many of the imported goods are perishables which can spoil and reduce the supply of foodstuffs amid an already high demand. As a result many firms are opting for alternative methods of shipping like the much more expensive option of air freight.
(Note: Moderately bullish on sea freight carriers, rail, trucking, logistics, logistics outsourcing, and air freight)
- Supply Chain Shortages: As if the bottlenecks weren't bad enough, there are but a limited number of domestic shipping firms. Firms that not only transport materials to businesses, or, finished goods to retailers, but also delivering orders to retail shoppers. Here we are once again talking about rail, trucking, mail delivery, air freight, logistics firms, logistics outsourcing, etc. So yet again we have an increased demand for shipping and logistics with but a limited supply. And while this demand will keep up for some time, many firms know it will eventually come back down to normal, and therefore, are very hesitant to expand too fast too quickly for fear that they will one day have too much fleet for future business.
(Note: Moderately bullish on rail, trucking, logistics, logistics outsourcing, and air freight)
- Semiconductor Shortages: Everything these days has a semiconductor. Whether its semiconductors, passive semiconductors, diodes, you name it, chances are if it was an electronic made in the last 5 years, it needs a semiconductor to properly operate. Indeed before the supply chain shortages hit critical mass, we were dealing with semiconductor shortages. Now we will not likely fix the semiconductor issue until we fix the supply chain issue. Once again as the economy opened back up & demand skyrocketed, semiconductors too experienced a complementary spike in demand. Semiconductors alone are preventing the automakers from producing at full capacity. There are not enough semiconductors to make vehicles. And with the holidays on the horizon semiconductors are in higher demand than ever. Even Sony had to reduce the number of PlayStations they could manufacture and ship due to component shortages and logistics issues. So expect the price of any new electronic device that has a semiconductor to increase in price.
(Note: Bullish on electronics & semiconductors)
- Vehicle Shortages: As noted with the semiconductors, vehicles are in short supply. As a result the quantity of vehicles demanded exceed the quantity of vehicles supplied. Therefore we not only have a shortage of vehicles but the price o vehicles have skyrocketed. Have you seen the empty lots at your local dealership? There's nothing to sell! People are ordering direct from factory. As a result people turned toward used vehicles which now are also in short supply. As a result people who could not afford the increased price of used vehicles resulted to maintaining their current vehicles. And as a result of people maintaining their current vehicles, the demand for auto parts & auto mechanics have skyrocketed. And I don't know many large firms that do not need a frequent supply of vehicles to maintain operations.
(Note: Moderately bullish to bullish on used car firms, auto parts, and car repair)
- Raw Material Shortages: Raw materials were the first to explode out of COVID. Wood, steel, ore, oil, & minerals … you name it, its all going up. The quantity of supply demanded exceed the current supply … and for many reasons.
(Note: Moderately bullish on miners, steel, mining equipment suppliers, and oil/gas producers … see energy shortage below for more detail on oil/gas**)**
- Increased Demand for Housing: Largely as a result of low interest rates incentivizing lending, we experienced a housing and construction boom in the middle of a Pandemic. Houses and industrial builds in many areas have skyrocketed in value. But this was not only as a result of low interest rates. When the federal government instituted a ban on evictions from rental properties, many took advantage by simply not paying their rent. The forgone payments to the landlord forced the renter to pass on the costs on to new tenants, which increased the cost of rental properties beyond that just owning a home in many areas. So people bought homes instead. Moreover many people moved out of urban areas to escape burdensome COVID restrictions which furthermore increased the demand of housing. Furthermore lifetime renting millennials saw the low interest rates as a great time to buy their first home. Finally, mortgage forbearance reduced a lot of foreclosures during COVID. Less foreclosures means less supply, less supply amid high demand results in higher prices.
(Note: Not very bullish on housing & real estate at this time but still moderately bullish on construction, furniture, paint, fixtures, and infrastructure**).**
- Energy Shortages: As we began to put the COVID economy behind us, more people are travelling to work, to school, and going on vacation. More recently international travel is opening back up. Moreover firms are expanding rapidly to meet demand and shippers are using more energy than ever. This all of course increases the price of oil, natural gas, jet fuel, and the fuel you pay at the pump. Making matters worse, no matter what your politics are, the current administration in the White House is the most ardently unfriendly domestic coal and fossil fuel administrations we've had in 5 years. OPEC, perhaps realizing that such demand will be but temporary for the next 1-2 years, refuses to entertain the Biden administrations request to ramp up oil supply. Oddly enough big oil hasn't been in this good of a position for the last 4 years where the increase of supply made it seriously hard for oil firms to profit. Energy is used for producing everything. When energy goes up the cost of everything goes up. When energy goes up, people spend more on energy and less on other things. So the increase in energy costs are a result of both increased post COVID demand and politics. Of all the issues we are experiencing with inflated prices, energy is among the easiest to fix.
(Note: Bullish on oil, natural gas, oil and natural gas equipment maintainers and suppliers, and perhaps oil exploration if the Biden administration would quit putting up road blocks**)**
- Worker Shortages: "Worker Shortages" is misleading. When people think of a "worker shortage" they generally think that we don't have enough workers to meet demand. They would be correct. But we should phrase it as "firms do not have enough workers to meet CURRENT demand." Lets face it we are rear view looking creatures. Simply because a firm doesn't have enough workers does not indicate that they cant beat previous profit/revenue, but rather they can not only beat previous revenue projections, but also be in a position where they cannot meet CURRENT demand. And just like anything else, when the quantity of labor demanded exceeds the quantity of labor supplied, we run into increased labor costs … namely wages. And wages are overwhelmingly the highest cost for most firms.
(Note: Bullish on staffing and outsourcing firms**)**
- Secondary & Tertiary Effects of too Much Demand … Conclusion: Lets keep this simple. You want to buy a car. That car is made from raw materials such as aluminum & steel. The car requires electronics. Those electronics require semiconductors. You need a labor force to put that car together. You need energy to manufacture that car. You need truckers & freighters to ship those cars or bring manufacturers the materials to make cars. You need equipment to make cars. In short 100% of the price of all components of that car, or the components used to make that car, have gone up. Still, you have a high demand market where people and businesses require vehicles, but the manufacturer cant meet that demand due to the lack of supplies available. Nevertheless the vehicle manufacturer still needs to pay for overhead costs to keep the doors open. And as so many people are demanding such a short supply of cars, the manufacturers simply increase the price of that car to meet the demand of the highest paying bidders. And this phenomenon is happening in each step of the chain to make that car from the folks who supply the materials, to the folks who produce the energy, to the folks who ship the finished product. When the quantity of goods demanded exceed the quantity of goods supplied, prices necessarily must go up.
- Monetary Drivers of Inflation: As a result of the dramatic initial downward shift in demand amid COVID lockdowns, the Federal Reserve made money cheap, essentially lowering interests rates to both incentivize borrowing and make borrowing more affordable. The result? Massive influxes of borrowing and lending which in turn flooded the economy with cash. At first this excess cash was used to make it through the pandemic. Later this cash was used by firms to expand rapidly to meet demand. People also used cheap money via extremely low interest rates to purchase homes, which increased the demand for housing. Eventually the Fed is going to need to raise interest rates to disincentive lending and cool off a hot economy. If allowed to persist for too long the influx of cash will lead to investments by firms looking to to stave off losing the value of money via inflation and thereby creating a massive bubble. There are already indicators of this happening by virtue of equity valuations in the market. (Note: the Fed has also been incentivizing investment in the stock market by buying treasury bonds on the secondary market which resulted in keeping the yields artificially low. As a result people were less inclined to buy treasury bonds and more incentivized to invest in other equity).
- Government Drivers of Inflation: The rapid inflation we are experiencing has not deterred President Biden for advocating for trillions in spending measures. The U.S. Government is a customer just like anyone else, and the government competes for the same goods and services you and I do. Increased spending will to some extent result in crowding out the private sector that competes for the same goods and services. Remember that an increase in demand with limited supply generally results increased prices. If the government spends too much, it can seriously hurt consumers in the form of increased prices. Moreover the Biden administration isn't the most friendly administration when it comes to mining for coal, oil, minerals, etc.. This inevitably leads to increased costs of energy and raw materials. (Note: This comment used a political figure as an example of a negative economic consequence. Do me a favor, take the example for what its worth to you, and realize I am not going to entertain heated political discussion. There is a cost and benefit to everything, and I don't have the time to entertain the talking points you pulled from a political webpage or favorable news site and tell you why you're wrong, when no matter how much the evidence is stacked against you, you're not going to change your mind anyway. Ergo a massive waste of time that benefits no one).
- Inflation is Excellent for Debt!: I will keep this one quick. Lets say you took out a 30 year fixed mortgage in 1990. You paid $90,000 for your home and have a mortgage of $400 per month. In the year 2019 your home is now worth $200,000 in market value but you're still paying $400 per month at a fixed rate. Through inflation your wages have eventually increased while your fixed rate mortgage remained stagnant. In short, you may have been scrimping for pennies when you took out the mortgage, but years later you can make your payment while working at a fast food restaurant. Neat huh? Inflation is excellent for debt ridden companies. As their profit margins increase over time through inflation they will find it much easier to pay off their long term debt. (Note: Perhaps this put some of the companies you were looking at into better perspective, and if debt was a major factor for not investing, then you may or may not want to revisit your decision.)
- Bullish Sectors You Can Profit From that I did not Mention Above: Industrial Chemicals, Industrial Equipment, Fertilizers, Farm Equipment/Construction, and Pesticides. As firms ramp up production they will increase the demand for industrial chemicals. Moreover, as food prices continue to increase the more land farmers will be incentivized to clear for additional farming which requires more farming construction, farming equipment, chemicals/pesticides, and fertilizers.
- The Canary in the Inflation Coal Mine: If the change in prices rise beyond the change in incomes to the point where people need to start economizing their necessities and forgoing their wants, we could be looking at a very serious correction.
Conclusion: I hope the pointers above have helped you better understand the inflationary environment and identify economically favorable industries/sectors. Please understand that I will be reading this over and over again to identify typos & unclear sentences. I may even edit it as people bring ideas to my attention. Anyway I hope you enjoyed it and can turn this into long term investment opportunities.
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