In a resurgent economy, inflation is looming

With such dynamic economic activity, lingering supply chain problems and labor shortages, it’s no surprise that inflation is skyrocketing. USA in October the producer price index increased by 8.6% year over year on an unadjusted basis, while the the consumer price index increased by 6.2% for the 12 months ending October – the biggest 12-month inflation increase since 1990. Costs are rising throughout the economy, including shelter costs, with rents moving at an annualized rate by 5%. We can expect rents to continue to climb next year, as new home sales are up 20% year over year.

Likewise, wage inflation is increasing in all key measures. Average hourly wages have increased 4.9% over one year in October, according to the latest non-farm payroll report. Unit labor costs have increased dramatically, at a Annualized rate of 8.3% last quarter after increasing at a pace of just 1.1% in the second quarter. For the 12-month period ending September 2021, salaries and wages increased by 4.2%.

Despite concerns about inflation, we are seeing a recovery in several sectors, with much stronger GDP growth expected for the fourth quarter. Last week, the Atlanta Fed forecast 8.7% GDP for the fourth quarter. I’m not convinced it will be that high, but it will definitely exceed the 2% rate in the third quarter.

This holiday season, we are confident that retail will not disappoint on the demand side, given excess consumer savings. But there will be ongoing challenges with the rising costs of getting goods to the shelves due to supply chain issues, wage inflation, and labor shortages.

How I allocate my portfolio, around 2022

While inflation is a concern, many companies have pricing power and significant free cash flow for mergers and acquisitions, share buybacks, and dividends across multiple industries. We have seen large conglomerates such as GE and Johnson & Johnson slower growing non-core spinoffs to increase shareholder value, which is good news for investors.

The global increase in COVID cases has resulted in a rotation to growth stocks. I’ve been in the same sectors for a long time in recent months, with my bar tilted towards value and cyclicals. I continue to favor reopening stocks, such as airlines, hotels, online travel bookings and home retailers, which are expected to benefit from the surge in consumer demand. At the same time, I like secular producers with large total addressable markets, buying when prices are attractive.

I also take a close look at retail companies, as the industry has significantly outperformed the S&P 500 and the rest of the consumer discretionary sector this year. Profits for home improvement retailers are strong, thanks to the strong real estate market, demand for home care products and low interest rates.

Low-cost retailers are also showing strength with consumer demand for a “scavenger hunt” experience, plentiful inventory, and higher-priced transactions. I am also seeing positive trends among auto parts retailers due to the high price and shortage of new vehicles, and the fact that many car owners choose to repair and maintain their existing vehicles.

As is often the case, the economic picture is currently mixed, with a return in consumer demand, solid industrial production and a promising outlook for Q1 2022 profits. My main point of concern as we approach of the new year is inflation, wait and see if the Fed will act as soon as possible to bring inflation under control. Time will tell us.

Stephanie Link is Chief Investment Strategist and Portfolio Manager at the national wealth management firm Hightower. She heads the company’s investment solutions group, specializing in outsourced investment director services, model portfolios, separately managed accounts, investment research and due diligence for highower advisers. Follow Stéphanie on LinkedIn and Twitter @ Stephanie_Link.

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