- October 12, 2021
- Blog , The Trusted Navigator - Bernhard Koepp
Q3 Market Review and Risk of Stagflation Bernhard Koepp – C.J. Lawrence – October 4, 2021 – YouTube Video & Transcript
In this video, Bernhard Koepp, CEO of C.J. Lawrence gives an update on what he is watching at the end of Q3 2021 and discusses the rising risk of stagflation.
Video Transcript
Bernhard Koepp:
Yeah. Hi there. This is Bernhard Koepp at C.J. Lawrence. It is October 4th, and I wanted to give you a quick update on what we’re watching at the end of the quarter. There are basically five things I want to cover. Number one, COVID-19 is actually receding. We’re seeing that in hospitalization rates that are coming down quite nicely all over the country, we’re seeing that also around the world, there was certainly a worry that the Delta variant would have a severe impact, it did, but the incubation rates went up pretty quickly and now coming down pretty quickly as well. So, that’s certainly good news. Number two, China. We are seeing a slow down unfold there. Chinese growth is very important for global growth, and we’re seeing that play out now in the real estate sector, there’s a company called Evergrande that has already defaulted on some of its bond obligations.
Bernhard Koepp:
The real estate sector is 15% of the Chinese economy. So anytime there is a severe disruption to the real estate sector in China, that will have an impact on growth. So it’ll be interesting to see how China copes with that crisis, whether they just paper over it. They certainly have the reserves to do that, but it seems they are right now, cheek picking losers and winners when it comes to the bond holders and shareholders. So it’d be interesting to see how that plays out. Number three, inflation. So there’s been lots of inflation news just in the last two weeks. It’s very interesting to see at what point interest rates started taking off again, it was really around September 16th. That’s when the 10 year treasury went from 130 to where we are now, 155. Again, that doesn’t sound like a lot, but in the bond market world, that is quite a move and has spooked the equity markets.
Bernhard Koepp:
So it’s interesting, if you look at the correlation between technology stocks and interest rates, there’s a negative correlation. When interest rates started moving up again, you saw the valuations compress on technology stocks. So you saw quite a severe sell off into the quarter end last week when it came to technology stocks. And we’ll talk more about that. So in terms of inflation, lumber is a good illustration of where we come from and where we are now. So coming out of the pandemic and the global shutdown in economies, we saw lumber prices surge all the way to $1,700. And that was back in May. So there was a lot of worry about inflation already back in the spring, then you saw lumber prices collapse again to 450. So you go from 1,700 to 450. So we thought, okay, inflation is not a problem. It’s August. And now we’ve seen a resurgence of lumber prices, again, up 33% to $630. So that’s a quite a move back up in lumber prices, which creates inflationary pressures all over the world.
Bernhard Koepp:
We’re seeing the same reflected in natural gas prices, coal prices and oil. And you saw the pictures out of the United Kingdom, where even the military has been deployed to manage the distribution of gasoline at gas stations, given the shortages that we’ve seen there. So supply chains are disrupted all over the world. One of the reasons is the demand is so overwhelming, so there was such a pent up demand coming out of the one year where basically everybody was unable to engage in economic activities. The unprecedented demand for goods and services has created a bottleneck in some industries that we’ve never seen before.
Bernhard Koepp:
So we’ve seen some anecdotes out of that from companies. Last week, we had Bed Bath & Beyond give their earnings outlook, and the stock got crushed 25% on the day. Basically, they said we can’t get any inventory. And this has been the pattern for a lot of retailers, especially clothing retailers who cannot get product that is produced in Asia and other parts of the world. So we also saw that in the release of FedEx. FedEx was talking about wage inflation. They’re having trouble finding truckers and truck drivers for that last mile of packaged delivery. So it’s interesting that this inflationary pressure that we’re seeing out of the supply chains is being reflected in the yield curve. That’s something we need to watch, because the economic activity has certainly slowed.
Bernhard Koepp:
The fourth thing we’re watching closely is the political debate in Washington. Certainly the infrastructure bill is at risk. There is a debate internally now amongst Democrats regarding the size, is it one trillion, or is it three and a half trillion? Hopefully there is something that will be passed, because certainly the infrastructure bill is something that is positive for equity markets longterm. If we do not get any infrastructure passed, that certainly would be a negative for equity markets. The other debate that’s troubling that we see every year is on the debt ceiling. There’s always this a game of chicken that’s being played on Capitol Hill when it comes to raising the debt ceiling. It’s crazy to me that the politicians agree on all the spending, but then when it comes to raising the debt ceiling, they seem to disagree on that. So either you get your house in order and not agree on all the spending, but playing politics with the debt ceiling is something that seems crazy to market practitioners and economists.
Bernhard Koepp:
Number five, technology stocks. That was sort of the last shoe to drop last week. Clearly technology stocks are not an inflation hedge. So if you have inflation worries rising and inflationary pressures rising in the economy, that has a negative effect on technology stocks in their evaluation. So we saw that play out quite severely last week. We like technology stocks. We own a lot of them, because the secular earnings power for these companies is still quite strong. But if you look at companies that are energy stocks, or materials, they have pricing power. So if we have this inflationary pressure in the economy, the only companies that really have pricing power and pass on that inflationary pressure are materials and energy stocks. So these are the net beneficiaries of an inflationary environment.
Bernhard Koepp:
So in closing, there is a debate now, are we in a stagflation type environment, or is stagflationary a risk? And stagflation is a term that basically takes together two concepts, stagnant growth, and rising inflation. So stagflation is not a good environment for almost every asset class that we invest in. So, that’s something that we should avoid. So that’s why we’re watching the inflation side very closely. And it is still our view that many of the inflation pressures that we are seeing are cyclical rather than secular. And we’re seeing that in the industrial commodities, as I mentioned, lumber and steel, and all these things, once demand comes down and some of the supply chain bottlenecks are resolved, these prices should come down again. But if you have inflation rising on the one hand and you have stagnant growth on the other side, or declining growth, we have a problem. So what’s our view on growth, GDP growth?
Bernhard Koepp:
So the third quarter, a lot of economists and including ourselves, we’ve reduced our expectation on third quarter GDP. If you think back to the second quarter of 2021, we were at about a six and a half percent run rate for the quarter. We are expecting about half that, and most economies are expecting about half that for the third quarter, that is due to the impact of Delta. But if you look at the fourth quarter, we expect quite a resurgence of economic activity to back to about the 6% level. So the big question, then what happens in 2022? Our expectation, as I said in my mid-year outlook, our expectation is that growth will slow into 2022, and we will have more moderate, but pretty good growth into 2022 and 23. So that’s where the rotation that has gone into the more inflation hedge type stocks like materials and energy will come back into the more secular growth type stocks that are on the technology side, or healthcare side, or financial side.
Bernhard Koepp:
So what’s our portfolio strategy right now? We like this barbell approach. On the one hand, we stick to our guns, which is the secular growth that we see amongst our technology stocks. They’re not as expensive as people make them out to be. A Microsoft or a Google, are actually selling at pretty decent and not too high multiples. And the other side of the barbell are industrials that are quite dominant, that we also call bulldogs. Again, these are the Emerson Electrics, and Jacobs Engineerings and Rockwell Automations, we like those a lot. And we’re being careful about companies that have certain exposure, either to labor costs. So we want to be careful about companies that have labor costs pressures, or companies that have exposure to China, where things are either becoming very difficult to operate in, because of the regulatory environment, or the severe slowdown. So going forward into the year end, we think our barbell approach will be quite good. So thank you for listening, and we’ll see you again the next time.
Bernhard Koepp is CEO and Portfolio Manager at C.J. Lawrence. Contact him a bkoepp@cjlawrence.com by telephone at 212-888-6342.