Maria’s Note: Maria Bonaventura here, Rogue Economics’ senior managing editor. Today, we hand the reins over to one of Nomi’s regular contributing editors, Eoin Treacy.
Eoin is a career analyst, writer, strategist, commentator, and lecturer. He’s known around the world for his knowledge of asset classes, sectors, and thematic investing. Today, Eoin shows us why we’re nearing peak inflation – and what it means for investors…
Inflation is the buzzword of the day. But what does that mean in the context of our distorted world?
Official inflationary measures are certainly higher today than they have been in years. Year over year, the Consumer Price Index (CPI) is running at 7%.
Why is inflation so much higher now than it was before the pandemic? And how much longer can that last?
I believe we’re close to a peak in inflation. In today’s essay, I’ll give you the top reasons why. And I’ll show you how to navigate it in light of the carnage we’re seeing in the markets.
What Peak Inflation Means for Cars and Semiconductors
One of the areas where we’re seeing signs of peak inflation is the car industry.
There is no doubt the pandemic upset the global supply chain. Car companies, for example, had to curtail production.
That has contributed to a massive surge in used car prices. It also means there are millions of people with cars on old leases waiting for a new vehicle to trade into.
As you likely know, we’re in the middle of a semiconductor shortage. This is affecting the ability of car companies to keep up with all the new orders.
When the semiconductor shortage eases and old leases expire, there is going to be a glut of cars that will need to be sold. By the end of this year, used car prices should be coming back down. That’s deflationary.
Taiwan Semiconductor, the biggest semiconductor company in the world by market share, will spend $40 billion this year to increase supply. Intel – the biggest semiconductor chip manufacturer in the world by revenue – will spend up to $28 billion.
By the middle of 2022, the worst of the semiconductor shortage will be over. That will allow factories to accelerate their manufacturing, and shortages will ease up.
What Peak Inflation Means for the Housing Market
But the car industry isn’t the only one feeling the effects of inflation.
Bond yields have also surged higher. Investors believe if the Federal Reserve does not do something, inflationary pressures will become a problem.
I agree with that conclusion. But I think the Fed only has to raise rates by 0.25% once or twice to get the result it wants. If I’m right, bond yields are already too high and could soon begin to come back down.
Right now, the market is pricing in more than four 0.25% hikes this year. As I see it, that’s not even close to realistic. Either way, rate hikes from the Fed could affect today’s hot housing market.
Higher bond yields have already pushed up mortgage rates.
Consider the Freddie Mac conforming 30-year mortgage rate. It tracks the mortgage rate available from government-backed lenders. It bottomed in January 2021 at 2.65%. As I write this, it’s 3.56%.
What does that mean for the housing market – and for homeowners?
The average price of a house in the USA is $389,400. At 2.65%, the mortgage payment would be $1,569. At 3.56%, it is $1,761.
In other words, someone buying the medium-priced home now needs $192 a month more than a year ago. And that’s before property taxes.
Another way of thinking about it is you need at least another $2,300 a year, in net income, to afford the median-priced home. That’s siphoning money away from other spending, which is also deflationary.
If I’m correct that the bond market is overreacting to inflation, then mortgage rates should peak soon, too.
As the Federal Reserve continues to taper its monetary assistance, the supply of new money will fall further. That should reduce price inflation in properties.
And we’re already seeing signs of a slowdown in home prices.
Take a look at the chart below. It shows the S&P CoreLogic Case-Shiller 20-City Home Price Index, year over year.
This index tracks the rate of increase in the 20 largest cities in the U.S.
As you can see, it peaked in July at 20%, but it’s still at its highest level on record. If home price inflation keeps moderating, that will take some of the pressure off wage growth, too.
That’s because one of the reasons people have been so eager to demand higher wages is because housing prices have been running away from their ability to pay.
All Signs Point to Lower Inflation Ahead
In short, all signs point to lower inflation in the near future. And a look at the charts backs that up.
Take a look at this long-term chart of CPI on a year-over-year basis. The one thing that stands out to me is how choppy it is. Periods of weak inflation followed periods of strong inflation.
Even during the Great Inflation of the 1970s, there were a great deal of swings in inflation. Every time inflation spiked, it bottomed at a higher level.
I’m expecting something similar for this decade. I don’t think we are going back to the low official inflation readings from before the pandemic.
After the impending peak in inflation fear, I expect it to hold higher average levels than before the pandemic.
What This Means for Your Money
Right now, everyone is panicking about inflation, so we are probably close to a peak. Many of the stocks that rely most on low interest rates and abundant credit have sold off aggressively.
This is a symptom of the distortion between the markets and the real economy, which our editor Nomi Prins has identified.
As Nomi has shown in these pages, the stock market is addicted to cheap money. When it is abundant, prices rise. With even a whiff that the Fed might remove it, prices fall.
With the Fed recently threatening to cut back on its money-printing, it makes sense that it spooked the markets.
Now, if you’re invested in the markets, and tech stocks in particular, you’re likely worried about the selling we’ve seen so far this year. But we don’t expect it to last long.
When the market wobbles, it scares policy makers. They will soon kickstart the money-printing machine – or at least, they will put on hold certain rate tightening plans. Then prices will begin to recover.
In fact, to me, the current inflation panic suggests we are very close to a new buying opportunity.
I’m watching the ARK Fintech Innovation ETF (ARKF). It tracks companies across the technology spectrum that are front and center of the greatest tech trends of our time.
It includes communication companies like Zoom and Twitter, financial tech (fintech) companies like Robinhood, and leading biotech firms like Editas Medicine and CRISPR Therapeutics.
I agree with Nomi’s argument last week that many of these new fintech companies will outstrip conventional banks.
The ARKF fund has more than halved in the last year. It is still falling, so I’d wait for the first good upside day before jumping in. It should do well when traders are less worried about inflation.
All the best,
Eoin Treacy
Contributing Editor, Inside Wall Street with Nomi Prins
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