Broker Check

December 2021 Commentary

November 30, 2021

The US economy is recovering from the pandemic, but volatility will remain high due to COVID variants and inflationary pressures…

A recovery but volatile… 

The good news is that the US economy is recovering from the recession caused by the COVID pandemic, but there are issues of concern which will lead to high stock market volatility. 

COVID variants and inflationary pressures are the key sources of volatility…

The COVID variant Delta has delayed the full reopening of the services side of the economy, which is about 50% of the economy.   Vaccinations to children and booster shots to all adults were expected to keep Delta in check, but now health officials have discovered a new variant named, Omicron, which has created uncertainty as to the effectiveness of current vaccines.  The Omicron news on Black Friday, caused all major stock indices to drop about 2.5%.

The recovery of the goods/product side of the economy has been too strong relative to supply.  This imbalance has led to shortages and caused inflation to rise to levels not seen in decades.  The US Federal Reserve Chairman had initially deemed inflation, transitory as it was coming off of pandemic lows, but inflation has been more persistent due to Delta related production shutdowns and an ineffective global supply chain unable to deliver products to retailers.   As a result, the risk of inflationary pressures has caused interest rates to rise to levels, that could hurt the economy and the financial markets. This is something that we will be watching closely.

Let's look at the inflation risk first...

Source: JP Morgan and Bloomberg

The US is the largest economy in the world with consumer spending accounting for 70% of its economy.  Services are about 67% of US consumer spending while spending on goods/products is 33%.  So consumer spending on services is typically twice that of what they spend on goods.  Due to COVID, consumers greatly reduced spending for services such as vacations, Broadway plays, restaurants due to lockdowns and health concerns, and shifted their purchases from services to goods.  This is the primary cause of inflation as the demand overwhelmed supply causing prices to rise.

Retail sales is a good proxy for product spending and the chart above shows the spike in retail sales as consumers reallocated their budget from services to goods.  This reallocation in spending overwhelmed the global supply chain, which is both fragile and complex, with many choke points such as the ports in southern California. 

In addition, retailers and auto makers compounded the problem by mismanaging the inventory to sales ratio since the Great Recession of 2007 – 2009, foolishly keeping inventory growth lower than sales growth to placate the short term sell side Wall Street analysts, so they can go on CNBC to say they beat the quarterly earnings estimates.  You can see retail inventory growth lag sales growth since the Great Recession in the chart above.

The US auto makers were major offenders, mis-managing their balance sheets with a short-term focus, canceling their orders of semiconductors during the pandemic; semiconductors manufacturers happily re-allocated auto chip production to higher profit areas like laptops to meet the wave of demand caused by the work from home trend.  This blunder will cost the US auto makers an estimated $210 billion in lost sales due to lack of semiconductor chips for 2021.  Why would you keep chip inventory low and cancel orders when the average car contains just $800 in computer chips with an average selling price of $45,000 for a car!  As a result, used car prices have spiked and is a main driver of higher inflation.

Goods/product inflation should begin to abate as consumers shift back to spending on services like vacations and cut back spending on goods.  Supply should also be able to catch demand helping to ease inflation, but this will take time.

The next inflation scare will then hit the services side of the economy.  This risk is much greater than product inflation as you can produce more lumber and semiconductor chips, but you can’t produce more skilled and experienced workers.  In addition, there is the Great Resignation occurring in 2021 as over 4 million workers have quit their jobs in each of the months of July, August and September!  The only way to keep inflation in check would be to increase worker productivity and/or entice retired skilled workers to re-enter the workforce. 

The biggest risk and source of volatility continues to be COVID variants and their negative impact on economic growth…

The first two quarters of the year brought strong economic growth, but the recovery stalled in the third quarter as GDP growth decelerated with the Delta variant surge, causing expected third quarter GDP growth of high single digits to come in at low single digits.  As I am writing this on the day after Thanksgiving, there are reports of another COVID variant, Omicron, which may be worse than Delta; scientists are worried that current vaccines may not be effective against Omicron.  All the major indices dropped around 2.5% for the day. 

Science will ultimately prevail over the COVID variants, but this will take time and the economic stall in the third quarter may not be the last.

Although we face challenges, we should not forget that we are in an economic recovery with further room to grow as the largest part of our economy, services, has not gotten back to pre-pandemic levels. 

Please reach out to your portfolio manager and/or relationship manager to address any questions or concerns you may have.

Happy Holidays!


Dan Moskowitz, John Lui and Brian McGeough