Broker Check

Inflation has arrived and it’s not just transient

August 06, 2021

Last week, the government reported real GDP in the US grew at a 6.5% annual rate in the second quarter and was up 6.4% at an annual rate in the first half of 2021. Real GDP is now 0.8% larger than it was at its peak just prior to COVID. 

The problem is that getting back to where we were just before COVID is a low hurdle to clear. Real GDP would have grown much faster if COVID hadn’t happened. In other words, the economy is smaller today than it would have been in the absence of COVID, which is to say the economy is healing but still has a long way to go before it’s fully healed. 

What’s more interesting is that when we measure the economy in terms of the volume of dollars being spent – nominal GDP, which reflects both real GDP and inflation – we are already very close to where we’d be if COVID hadn’t happened. Nominal GDP is not only at a record high but up at a 3.1% annualized pace since late 2019. So, how is it possible that the total amount of spending is close to “normal” but “real” GDP is still below par? 

It doesn’t take a Ph.D. in economics to figure out that inflation is the difference. Since late 2019, GDP prices are up at a 2.7% annual rate. And, yes, that includes the steep drop in prices early in 2020, during the onset of COVID. GDP prices grew at a 6.0% annual rate in the second quarter, the fastest pace for any quarter since 1981. The rise in inflation is what you get when the government implements an unprecedented level of stimulus to support incomes while implementing policies like shutdowns and overly generous unemployment insurance that stifle production. 

It’s what you get when demand outstrips supply and this is exacerbated when the central bank prints excess amounts of new money. Inflation has arrived and it’s not just transient. In the near future, we expect continued solid economic growth. Inventories plummeted in Q2 as businesses had to dip deeply into their shelves and storerooms to satisfy consumer demand. Customers with newly printed money are showing up to buy goods and services, but businesses are struggling to find workers to produce more. 

In turn, depleted inventories mean plenty of room for more production in the year or so ahead. As extra unemployment benefits wane, employment will rise and spending will come from production, not artificial stimulus. The government poured massive fiscal stimulus into the economy during the past year, or so. Yes, Congress is likely to pass an extra spending bill or two later this year, but this additional government spending will be spread out over years, unlike the massive checks sent out earlier in 2021. 

What this means is that the impact from stimulus will wane. Meanwhile, damage from shutdowns will linger. Many supply-chain issues will indeed be resolved, and some price pressures will ease, but the thought that real GDP will grow faster than nominal GDP is fanciful. With the money supply having risen so rapidly, and the ability of the economy to keep up with that growth diminished by a more burdensome government, stagflationary pressures (slower growth, higher prices) have been building. We don’t expect those pressures to disappear. So, while there will be volatility of data in the quarters ahead, the GDP data is exhibiting the seeds of that stagflation. This is what we saw back in the late 70’s. Not a pretty picture and one that will put pressure on politicians to stop the money flow…Good luck with that. 

Real Estate

Breakneck. That's the best way to describe the pace of the 2021 housing market. The bidding wars got so intense this year that home price growth set an all-time record. But the tide is turning. The rush of buyers into the housing market during the pandemic absolutely crushed housing inventory (the number of homes on the market) with that figure falling for 12 consecutive months. By April, housing inventory was down a staggering 53% from a year earlier. However, the trajectory has flipped: For two straight months the number of homes for sale has gone up. Homes listing on rose 3% in May, then again by 9% in June. That's not all: We learned last week that new home sales are falling—their pace in June was the slowest since the onset of the pandemic.  Every indication is that the market is shifting a bit in buyers’ favor.

Why the sudden cooling? Home shoppers are finally showing some reluctance to pay top dollar. "The housing market was too hot for its own good over the past year, and we’ve seen some buyers bump up against an invisible price ceiling," Ali Wolf, chief economist at Zonda, a housing market research firm, tells Fortune. A Zonda survey of homebuilders last month finds that 61% of builders are seeing more resistance from homebuyers.

This buyer's hesitation was expected. After all, home prices can't continue to grow at a17% year-over-year rate indefinitely. At the end of the day, household budgets can stretch only so far. So for those that are trying to sell rentals and homes, you may have missed the highs or multiple offers. It is still a perfect time to sell because your price will still be higher than if you wait. Real Estate will remain stagnant to down for the foreseeable future, so don’t put your sale on hold. It is not going to get better, and stocks are still undervalued. Move money to where the value is.  

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