With the notable exception of last summer where shares in the US climbed through much of July, this summer is proving to be a more volatile affair as seen in the past few weeks and especially Monday. Lighter volumes in the summer always seem to stoke volatility and a few narratives are competing to take hold which may give investors reasons to take pause and take some gains.

Delta Dealings

The first is the worry that the Delta variant of Covid is going to lead to sporadic shutdowns and the gradual reopening is going to be put off, which will affect near term profits. The issue with this view that is many seem to be anchoring themselves in the past, that we can hark back to the work days of yesteryear and all will return to how it once was. The reality is that we are underestimating our capacity to adapt and that we are in the new normal. This will be a normal that includes more flexible work arrangements. Many workers have now realized the notion that commuting and prepping to physically show up to work every day were a huge waste of time out of our daily lives.

That large financial employers such as Bank of America, Goldman Sachs and Morgan Stanley are pressuring employees to come back shouldn’t be too surprising but the reactions of their employees may provide some surprises to their bosses. Although still anecdotal, there seems to be much rumbling by the mid levels down about being forced to come into the office by management that is older and coming off as out of touch with a shifting workforce. No doubt some will abide by what the boss says but many businesses that don’t value physical presence for its own sake will take advantage of the situation to pick up disaffected talent. Dan Price, CEO of Gravity Payments captures what many feel in terms of office culture and on the job hunt.

Why should the market care either? Although the Fed is still backing up much of the market through QE, it’s clear that some parts of QE may be overheating the market. The mortgage market most of all comes to mind but shares and even bonds, despite the inflation controversy, remain dear. Norway, New Zealand and Canada clearly see the home price as well as other asset price increases year over year as a looming threat to their economies and have dialed back their QE programs, some signaling higher rates are not far behind.

Too Focused on Inflation?

For all the talk on inflation there is one big disconnect: bond prices. The 10 year treasury note now sits around 1.21%, a level not seen since February when the inflation talk first started. Even if near term inflation sees a bump, this lends credence to those that argue that long term inflation expectations have not changed significantly.

BMO Capital Markets Strategist, Brian Belski is a dissenting voice when it comes to the inflation narrative. In a recent Yahoo Finance interview he posits that markets have been too focused on momentum and macro factors and are not taking into account a more “normalized” business cycle whose share returns rely more on fundamentals.

He also argues that much of the inflation we are currently experiencing in the US is supply chain driven, which I tend to agree with. Rental car prices are up 88% year over year but housing in general is only up 3% and rent is only up 2%, right in line with the Fed’s long term target. My own inflation hedged investment, the Vanguard Materials ETF (VAW) is down nearly 10% from its peak in early May.

What may actually be at the heart of much of the headline inflation is actually supply chain issues which are being created by lockdowns across the world. From a semiconductor shortage delaying car manufacturing to the staff shortages in the airline industry leading to higher priced flights, something which was nearly unthinkable a year ago.

What may eventually take the spotlight as Rana Foroohar argues is that disinflationary forces may actually start to take hold on the economy again once the stimulus checks have run out and the revenge spending has died down. This could be driven by increased digitization, which many companies invested in heavily during the pandemic. Think ordering your drinks and food at a bar through an app which requires less staff on hand to serve you. All of the sudden, labor costs can be cut out and prices can flatten or even lower to attract customers.

Changing demographics could also play a part in this as I have argued in a number of posts in 2019. As the rich world has aged, the pool of potential workers shrinks and the number of retirees dependent on them climbs. Workers, especially those with children have to spend more than those in retirement, on transportation, vacation, food etc, the shrinking younger population has proven to be disinflationary. The saving grace for the US from this could come through immigration but that has become politically contentious in recent years and immigration has dropped off.

Finally the work from anywhere revolution that the bank CEO’s are trying so hard to resist could also prove disinflationary. Pricey public transport systems are seeing lower volumes, if this solidifies, future transit projects could be scrapped due to lack of demand. A drop off in demand for office clothing could prove permanent and most importantly, commercial real estate could see a real reckoning as companies transition to smaller shared work spaces from multi-floor footprints.

Although it’s not as sexy an opinion, I do side with the Fed that the inflation we are experiencing will be transitory in nature. The few caveats to that are the questions of how house prices will rise if we keep constructing bigger and better homes (price per square foot and taking quality into account has actually meant home prices have been flat for 40 years in real terms) as well as if the green tech revolution truly takes form, commodity prices could remain elevated for many years to come.

Don’t Count Out Tech

This could point towards continued exceptionalism for the tech industry when it comes to earnings. The investments in tech that “old” economy firms need to make will eventually involve big tech firms who can take advantage of economies of scale in terms of costs. Continued work from home will require stronger investments in cyber security and internet capabilities, those who aren’t able to offer this to employees in a safe and secure way currently may suffer from losing out on talent.

A recent Wall Street Journal article pointed out that big tech accounted for half of the 7% gain that the S&P 500 saw from May 12 to July 9. Again, this likely points to what Brian Belski pointed out in that fundamentals of stocks are going to become more important going forward as the hot economy settles down to a more normalized growth rate somewhere around 2%.

For those looking for less volatility, one call that was made early in the year which has panned out relatively well we’re muni bonds. Longer maturity muni bonds have outperformed with a flattening of the yield curve in the first half of 2021 and the massive federal spending coupled with reopening, has buoyed the credit profile of municipal borrowers. Year to date investment grade muni returns have come in around 1% while high yield returns have come in around 6% according to PIMCO.

As always keep in mind that we are hard wired biologically to pay attention to bad news and the media outlets know this. Despite all the fears about home prices, Covid and inflation, things are still picking up and companies are expected to post some of their best earnings ever this season. Optimism pays in the long run.

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