Two legacies of the Covid-induced worldwide economic shutdown (or at least major disruption) seem to be higher levels of inflation and an increased number of workers (at least in the US) deciding to call it quits. Inflation, I believe, is a direct result of the shutdown and governments worldwide believing they could turn world economies off and back on again like a water faucet with little impact. Absent Covid, inflation would not be a problem now. The increase in the number of people retiring, however, has roots more in demographics than in Covid. Let’s look deeper.

Inflation

More evidence comes out seemingly every day. Today, this article on Fox Business states that the median expectation of inflation over the next year is 5.3%, which is a lot higher than the Federal Reserve’s 2% projection. Rising oil and energy prices continue to play a role, as this article about natural gas’s rally and this article about Saudi Arabia’s increased shipments to Asia attest. Now, as the information technology sector has exploded as a part of the world economy and the influence of the energy sector has ebbed, we aren’t necessarily going to experience 1970’s-like inflation or stagflation. However, rising energy prices will cause inflation, whether you drive an electric car or an “old-fashioned” gas-powered contraption. Then there are the continuing supply chain bottlenecks. My own eyeball inspection of the queue of cargo ships waiting to be unloaded at the Port of LA/Long Beach tells me that particular bottleneck is not abating. Christmas is coming soon and retailers are telling shoppers to get started now. Hope they have room in their houses to store stuff in secret for a couple of months. Lastly, there is the possibility of a US Budget bill with a price tag of somewhere between $1.5 Trillion and $5 Trillion. Apart from the politics of the budget, when the government infuses $Trillions into an economy that is already supply-constrained, even in the short term, prices are bound to increase. I have stated before that I believe high inflation is more of a short-term phenomenon, but the speed at which these supply chain issues can be resolved will dictate how quickly the inflation rate will be more normalized. Also, the smaller the budget price tag that is ultimately signed into law, the less likely higher inflation will become an issue.

Resignations

This article posted today says that 4.3 million American workers quit their jobs in August, the most in over 20 years. Workers in food service and retail led the way, and who can blame them? The motivation to want to work at a restaurant now, after having been laid off perhaps for weeks or months during the past couple of years, is probably not it once was. It is likely that many of these former waitpersons are now pursuing their dreams in the information technology sector or some other job that offers more stability. However, I believe demographics plays a role as well. The “Baby Boom” peaked during the late-1950’s, and people born then are now in their early 60’s. Though they probably would have been looking to retire sometime during the next few years, the disruptions caused by Covid have likely tipped a lot of them to retire sooner than they otherwise would have. So, I look at the phenomenon of increased numbers of workers quitting their jobs as part Creative Disruption – workers seeking more stable employment – and part ageing demographics. Regardless, workers quitting is inflationary. Restaurants either have to pay its wait staff more money and thus increase prices on the menu to remain profitable, or dip lower down in the skill level of the workforce, which is probably not to the restaurants’ collective benefit.

IMO

The water faucet analogy was never going to happen and we are now seeing how far-reaching the effects of what we have been through and are continuing to go through on display. The narrative has been that Covid is on the retreat and we are now on the upswing with respect to macro economic performance. However, things like product shortages resulting from supply chain issues or fed up workers moving on to better pastures intervene in the narrative. That’s why you have free markets and buyers and sellers engaging in everyday commerce. I believe in the long term the government stimulus is inflationary and will result in higher asset prices, including higher corporate earnings and higher stock prices. It won’t pick winners, except to the extent that larger, more well-capitalized companies will probably grow at a more rapid rate than will smaller insurgents. Stay long the larger-cap indexes and you should achieve your financial goals if you are a long-term investor.

October is not off to a good start for stocks in the tech sector. After a weak September, the tech-heavy Nasdaq 100 index is down today (Monday 10/4) about 2.3% as I write this, and it is down about 10% from the highs it reached in early September. There are several reasons that pundits say are causing this sell-off, but there is one reason that is not given that could mean that this sell-off will be short-lived. Let’s examine.

Rising Interest Rates

One stated reason for the tech sell-off is rising interest rates, and specifically rising US Treasury rates. This is not because investors are going to sell their tech stock holdings and take their money and buy 10 Year US Treasury Notes because the yield on those Notes has risen from 1.3% all the way to 1.5%. Instead, rising Treasury rates cause a tech sell-off because the “risk free” rate is now higher. Remember that the value of a corporation today is its projected future earnings stream discounted back to the present day, with the discount factor equal to the “risk-free” rate (i.e., US Treasury rates) plus a risk coefficient specific to that corporation. When the risk-free rate goes up, even by 20 basis points, then the discount factor also goes up, and the resulting corporate valuation goes down. Rising interest rates are therefore a valid reason why sky-high tech valuations could tumble, because those sky-high valuations were previously justified based corporate earnings being discounted at such a low rate.

Facebook Issues

Last month, the Wall Street Journal ran a series of articles from “inside” Facebook that portrayed Facebook as a corporation focused solely on profits at the expense of teenage girls and their self-esteem and of political consensus and continuity, among other issues. Then, last night on CBS 60 Minutes, one previous Facebook employee went public with information she had copied and taken while she worked there. All of this is bad for Facebook and its stock. FB is down 5.7% today and 15.7% from early September as I write this. Radio silence so far has been the reaction from Facebook management. Also, as Facebook goes, so go the stocks of derivative companies whose models and future prospects are tied to Facebook. What companies will want to advertise on a platform that knowingly proceeds with a business model that causes harm to teenage girls? Is Facebook in the process of being canceled by pop culture? This could go either way, but I believe Facebook management is pretty savvy and that a sincere mea culpa would go a long way toward healing. Too much is at stake if they don’t show some remorse.

Political Uncertainty

A third reason stated as to why tech stocks are selling off is uncertainty as to the Federal Budget, debt ceiling expansion, infrastructure spending, and even tax and capital gains rates for next year or even, unbelievably, this year. Specifically, these are issues that the Democrats in the House and the Senate need to reach not just consensus but unanimity on. Unanimity because their majorities in both chambers are razor thin, and the Republicans are in near unanimity that any Democrat plan is a race car speeding in the wrong direction. Infrastructure may be bi-partisan but that’s probably all that is. If we don’t know what tax rates are going to be, then how is that good for investment? I believe this will drag out for quite a while because there is limited political incentive otherwise. The longer this uncertainty does drag out, the worse it will be for the stock market.

Supply Chain Disruption

As I live in Newport Beach, CA, and it was a beautiful morning yesterday, my wife and I went for a walk on the beach. Before our eyes were two of the biggest news stories in the country: the very sad oil spill off the Huntington Beach coast that is due to a leaking pipeline from an offshore oil rig, and also the queue of cargo ships waiting to unload at the ports of Los Angeles and Long Beach. Your and/or your kids’ Christmas presents could very well be sitting out there on a ship that is temporarily anchored off of South Orange County. Tech stocks are suffering because of this shipping and unloading bottleneck because a lot of high-tech stuff is manufactured and/or assembled in Asia. Delays in shipping that stuff means delays in booking sales by the companies selling that stuff. If you view Amazon as a high-tech company, its stock is actually virtually unchanged for 2021 as of today specifically because of supply chain disruptions. This is quite a reversal for AMZN after the barnburner 2020 stock performance (up about 80% for the year). Though the supply chain may not be as important for software companies, it certainly is for the hardware companies that require the software as well as vendors such as Amazon that are part of the supply chain. These supply chain disruptions are a result of the Covid economic shutdown worldwide, and though these issues should gradually go away as more people worldwide get vaccinated and Covid becomes endemic, it could take a long time for this to happen; years instead of months.

Corporate Earnings

The big nullifier with all of these could be corporate earnings. Poor current corporate earnings is not being given as a reason why tech stocks are selling off. Certainly, any and all of the reasons given could negatively affect corporate earnings in the future. The extent to which these mega-mega-cap high tech companies avoid all of the minefields out there and continue to produce earnings that are at or above expectations will ultimately drive the market.

IMO

I have not sold any of my holdings in the Nasdaq 100 index (I do not own individual stocks in that index). All of the stated reasons given as to why tech stocks are selling off are valid reasons, but I am not convinced that any of these will be bad enough to tank any one stock or the entire sector. I view the Facebook troubles as pretty severe but Facebook’s management must know the peril they are in and I believe they will make it through, bloodied but not broken. Batten down, but ride out the storm. That’s my opinion, and you can use it however you want.