C.J. Lawrence Weekly – Inflation Counter‐Forces in the New Economy

In the previous millennium, strategists and economists would sometimes gauge inflationary pressures by measuring and comparing the prices of New York City taxi medallions versus the price of a seat on the New York Stock Exchange. The price for a NYSE seats, which allowed the limited number of holders to trade stocks on the floor of the exchange, peaked in 1999, at $2.65 million, then dropped to $975,000 in 2005. Seat prices rallied later in 2005 on the announcement that the NYSE and Archipelago would merge, become a public company, and exchange seat licenses for IPO shares and cash. But the point had been made that the value being created in stock trading was in networks and no longer in exchange floor real estate. Meanwhile, NYC taxi medallion prices peaked in 2014 near $1.3 million. Several were auctioned off last week for less than $200,000 each. The commonality between the declines of these two once prized assets is the deflationary pressures of competition and disruption. The rapid evolution of electronic trading networks doomed the on-site, in-person trading floor, while disruptors like Uber and Lyft threaten the once protected franchises of NYC taxi medallion holders.


Today’s disruptors are doing the same thing in mature industries throughout the economy. The new “gig” economy has introduced deflationary forces that some feel could challenge the traditional cycle of inflation. Economic history tells us that the correlation between labor markets and inflation is tight. For inflation watchers, that means the current set-up suggests higher prices are ahead. Labor conditions are tight, the economy is growing, monetary policy remains relatively accommodative, and the U.S. economy recently received a healthy dose of fiscal stimulus. That is a potent inflationary mix. Trade restrictions, if imposed, would further contribute to upward inflationary pressure. A confirmatory signal has been flashed by the benchmark U.S. 10-year treasury bond yield, which closed the week at 2.65%, up 25 basis points in the last month.


But the rate at which prices rise, the amplitude of the increases, and the duration of the pricing cycle, particularly in certain segments of the economy, are less clear in the modern economic era. E-commerce and the “Amazon effect” have helped to drive prices and margins of most consumer goods to historic lows. Hydraulic fracturing has revolutionized the oil and gas industry, by dramatically reducing the response time to imbalances, and constraining the industry’s ability to raise prices. Cloud computing has democratized software consumption and modularized previously one-sizefits-all product offerings. A recent announcement by a group of hospital executives suggests they will collaborate on the development of their own generic drugs to compete with established pharmaceutical companies and distributors. New technologies in agribusiness and ranching are increasing crop and herd yields and are improving the resiliency of supply lines. These are just a few examples of the deflationary forces at work in today’s economy. Many of these trends are not new, but the pace of change appears to be accelerating. Equity investors should be wary of mature companies in industries where price erosion is prevalent. Inflation certainly looks to be on the rise, and the reflation trade may still have some legs, but history suggests that long-term equity investors are well served by owning companies that innovate, possess pricing power, and grow market share in any economic environment.

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