In the October issue, we look at lingering inflation from global supply chain issues.
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The economic recovery and inflation are increasingly being shaped by supply-chain issues related to labour shortages and production bottlenecks. For example, a scarcity of US construction workers has hindered home building, while semiconductor chip production has recently depressed auto sales a little. In the EU, a record 40% share of manufacturers surveyed in August by the European Commission reported that a lack of equipment and materials were factors limiting production1.
Meanwhile, transport costs have surged, with container shipping fees from China to Europe up sevenfold from last year2.
While growth may ebb and flow as supply chain logjams are resolved over time, shortages could nonetheless have a lingering impact on inflation. Critically, inflation is now showing signs of broadening from a shortage of chips used in car production to other sectors in the economy. For instance, furniture retailer IKEA is experiencing a shortage of up to about 10% of its product range in the UK, due to transport issues and the availability of raw materials3. KFC, a fast food chain has had to offer a limited menu as the poultry industry is suffering from a tight labour supply. Moreover, labour shortages are forcing employers to raise wage rates: Amazon increased its average starting wage in the US by around 6% in May in its bid to hire 125,000 transportation and warehouse workers4. In the UK, following a run at fuel pumps around the country, lorry drivers can command higher salaries.
Arguably, a deeper concern for higher future inflation is that rents are on a rising trend and have yet to be captured in government statistics. Apartment List, a website that captures more than 5 million US rental properties, reported that national September median rents are up over 15% from a year ago, against a 2.8% gain for CPI shelter prices from the latest data in August5.
In short, provided the business cycle does not end abruptly, the macro back drop is still relatively conducive for equities over bonds – see our August Investment Outlook. Nevertheless, the risk for markets is that higher inflation becomes more entrenched in the economy and this hangover forces central banks to tighten monetary policy prematurely. The uncertainty of inflation, and the fact that the ECB announced a reduction in its asset purchases (i.e. Quantitative Easing) in September, could potentially lead to greater market volatility over the next few months.
Nursing a stimulus hangover in 2022 As the world economy recovers from Covid-19, governments are looking at ways to shore up public finances after the unprecedented cost of pandemic relief packages. After all, the IMF estimates that gross general government debt will reach a record 99% of GDP in 2021, up 16% from the pre-pandemic 2019 level.
A sizeable chunk of the additional tax revenues expected to be raised over the coming years will land on corporates, and especially those that benefited from the post-pandemic recovery, like “Big Tech” companies. Yet, we do not see a material negative drag of higher taxes on lower company earnings over the next year. True, G7 leaders agreed in July to seek a minimum 15% global tax on “stateless” multinational corporations in each country they operate, but there are plenty of unresolved challenges in the proposal to establish a Global Minimum Tax (GMT). First, not all members of the OECD/G20 have joined a plan to reform international taxation rules. Second, it could take some while to develop the infrastructure to deal with information to audit profits and taxes by jurisdictions of large multinationals. Third, even if there is agreement by G20 nations when they meet on 28-31 October to finalise terms of the deal, it could still take some time for a GMT to become effective, as there has been very little discussion on how to resolve potential disputes. And fourth, the G20 has no authority to force nations to adopt the plan and it would still need to be approved by every county’s legislature. Given the complexity involved in changing the international tax code, a full adoption of the OECD/ G20 plan is unlikely to happen in 2022.
Domestic taxes are on the rise. For example, the UK government announced that it will raise the National insurance rate by 1.25% for both employees and employers, along with a similar increase in tax on dividend income from April 2022. This is to support the NHS post-pandemic and reform social care. According to the Institute for Fiscal Studies, taxes and contributions would amount to 35% of national income, the highest rate since the days of post-austerity WW2. In the US, Congress is also looking to partly recoup the cost of the pandemic and to fund additional spending on infrastructure, healthcare, education, and “green” investment through higher taxes on wealthy Americans, corporates and enhanced tax enforcement.
Nonetheless, households and businesses are in decent financial shape to absorb higher taxes. Rising job creation and elevated personal savings left over after take home pay provides the financial wherewithal to sustain consumer spending during this business cycle. Businesses are also highly profitable. The MSCI All Country forward profit margin is up to a record 10.7%, an increase on the pre-pandemic level of 9.4%6. On balance, the relative aggregate financial health of consumers and businesses post-covid should provide equities with a cushion to absorb tax cost headwinds.
1,2,5,6 Refinitv/Smith & Williamson, data as at 30 September 2021
3,4 Bloomberg, data as at 30 September 2021
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