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The Terrestrial Twenties

• The hot growth economy we wrote about last May manifested in explosive output and rates of inflation not seen in decades. 

• The Federal Reserve (Fed) was slow to respond to the overheating economy and has forced markets to price in a rapid tightening of financial conditions, which alongside exogenous shocks in Europe and China have caused leading growth indicators to soften.

• A cooling of demand could be helpful in moderating high inflation, but longer-term demographics and other factors may leave inflation settling above the Fed’s (current) target, creating staying power for inflation hedges and reflationary exposures in portfolios.

The Outlook for Growth is Softening

The last two years have hardly resembled a natural business cycle. Governments shut down their economies and turned them back on with lockdowns and re-openings, and provided record levels of fiscal and monetary stimulus to stabilize the economy and financial markets. The combination of these events shifted consumer behavior and increased their cash levels significantly, resulting in the highest inflation figures we’ve seen since the early 1980s. The movement of goods continues to be irregular as supply chains remain understaffed from renewed COVID-19 restrictions in China. While the “recovery” stage of the pandemic era brought about explosive growth in output and rising inflation, the next stage of stabilizing the global economy to trend growth and inflation is bringing new challenges.

20220517-chart-1Like the equities market, the Institute for Supply Management (ISM) Manufacturing Purchasing Manager Index (PMI) is a leading indicator of economic growth. When this value is above 50, it indicates economic expansion; below 50, it indicates contraction. After averaging a reading above 60 for 12 months straight for the first time since the 1980s, it is finally starting to roll over. The current reading is 55.4. Purchasing managers are softening their outlook on rapidly tightening financial conditions and simultaneous exogenous shocks in Europe and China. Interestingly, the forthcoming softening of demand might actually be the best medicine as it could alleviate upward pricing pressure on housing, goods and labor. With that said, it’s doubtful that we resume the 2010s period of disinflation and secular stagnation. The emergent forces of de-globalization, clean energy investment and hybrid work are colliding with demographic dynamics in the US to keep upward pressure on growth and inflation.

Demographics are Reflationary

When examining the differentials in demographics by consumption cohort for the next decade, we see an expansion in the number of people in their maximum spending years relative to those in their maximum saving years, year-on-year until about 2035. The last time spenders inflected higher relative to savers like this was the mid-1970s, when the baby boomers entered the maximum spender cohort and remained there until the late 1990s. From that point forward, the number of spenders declined relative to the number of savers year-on-year until the mid-2010s as the baby boomers entered the max saver cohort. For the next 8 years this “echo boom” of max spenders will grow on a marginal basis relative to max savers by between one and two million every year. We believe this demographic trend alongside the broad acceptance of hybrid work has opened up significant demand for housing, which in turn creates demand for raw materials and energy.

20220517-chart-2The Terrestrial Twenties

For the last 15 years, investment dollars chased Big Tech and a myriad of start-ups attempting to monetize attention and disintermediate existing businesses via digital experiences and mobile devices. Investors became obsessed with these asset-light operators pursuing growth initiatives with five or ten year plus horizons. The recent shift to a higher inflation regime and tightening financial conditions has caused a 40-year bond bull market and hyper-growth stocks to experience their worst year-to-date losses ever.

In the next decade, we believe the outperforming investment themes that were characterized by monetizing digital or virtual experiences will be contended by those focusing on the physical resources of the earth. The lack of investment in commodity-related sectors over the last cycle, increased public investment in green technologies, a recovery in housing and the refactoring of global supply chains to prioritize control over cost are all factors strengthening the secular reflation story. As a result, we continue to view inflation hedges and reflationary exposures as being important allocations for the total portfolio.

Important Disclosures & Definitions

Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.

ISM Manufacturing PMI: measures the change in production levels across the US Economy from month to month.

S&P 500 Index: widely regarded as the best single gauge of large-cap US equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.

One may not invest directly in an index.

AAI000214 6/30/2023

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