Wages and Rent Driving Longer-Term Inflation
By TRG Advisors on November 12, 2021
Wages and Rent Driving Longer-Term Inflation. We’ve discussed inflationary pressure for a while and last week both the Producer Price Index and Consumer Price Index came in hotter than expected. In October, PPI hit +8.6% y/y, tied for its highest ever; CPI was up +6.2% y/y, its sharpest increase since 1990. While it was widely expected that CPI and PPI data would be high, now it will be important to watch if this leads to demand destruction going forward. So far, consumer strength has been resilient and companies have been able to increase price.
In addition to demand, we are watching rental increases, which rose 5% annualized in the CPI report. This and wage growth of 4.9% are the stickier parts of inflation.1 In fact, the Dallas Fed now expects +6% increases in rent by 2023. Higher rental costs historically lag rising housing costs, and housing prices have been reaching new highs consistently since the pandemic. Potential home-buyers, specifically first-time home buyers, are being forced out of the buying market and into the rental market, adding to demand and higher costs.
Profit Margins are Strong. Given the rising cost environment, many companies reported better than expected margins in Q3 because of strong pricing power and demand. Value companies grew Q3 EPS by +49.0% y/y, while growth companies grew EPS by +27.1%. Globally-exposed companies also grew earnings more than their domestic-only peers (+48.4% vs. +33.2% y/y). 2 Businesses will need to continue to balance raising prices with the potential for demand destruction, and although it’s a fine line, demand has remained persistent.
Hospitality companies have indicated very limited capacity in travel and lodging due to demand, along with record October earnings in select desirable vacation destinations. Bookings for next year are also higher than historical, according to some companies we follow. ISM Services expansion, a leading indicator, reached a record high in October and companies are anticipating demand to stay high in 2022. Significant job openings, good leading indicators and higher housing prices give us confidence in the consumer and a strong fundamental economy.
Bond Yields Reacting to Inflation Data. Inflation concerns were the driving factor in the market last week, as the 2-year treasury yield rose 9 bps, and the 10- and 30-year yields increased 13 bps each. Municipals rallied on the week, with yields 1-4 bps lower across the curve. High Yield corporate spreads widened by 3 bps while Investment Grade widened by 2 bps.
December 3rd Debt Limit. Washington insiders are indicating that the “Build Back Better” infrastructure bill has about a 50/50 chance of getting passed. Between the looming debt ceiling (December 3rd), multiple holiday breaks and partisan disconnect, there’s a lot to do in just a few short weeks.
GE and JNJ Announce Splitting and Spinning Off their Businesses, Following Trend. Conglomerates have announced in recent weeks and months splitting into separate companies or spinning off businesses to unlock value. Other recent examples include XPO Logistics (XPO) spinning off their pure-play logistics unit GXO Logistics, and IBM (IBM) spinning off their infrastructure business, Kyndryl, during Q3. These companies believe they’ll attract better multiples and better growth as separate entities. It’s a classic example of the sum of the parts being worth more than the whole. A corporate decision to separate those business units into individual companies allows them to better allocate resources and grow relative to its true peers.
The Week Ahead. Economic Data: Retail Sales and Industrial Production (Tuesday). Corporate Earnings: WMT (Tuesday), HD (Tuesday), LOW (Wednesday), TGT (Wednesday), TJX (Wednesday), CSCO (Wednesday), NVDA (Wednesday).