Will Inflation Wreck this Economic Recovery?

By Mitchell Anthony

January 7, 2022


2021 was a great year of economic recovery from one of the worst events that ever took hold of the global economy. The pandemic! Unfortunately there was some collateral damage and an inflationary cycle began that is difficult to understand.  More importantly expectations for inflation have risen dramatically.  Inflationary expectations have been anchored for over a decade at very low levels of 2-3%. However the CPI is currently measuring 6% inflation and the PCE (personal consumption expenditure index) is at 4.7%.  These high levels of inflation have not been seen in decades and many believe they will not be sustainable because they have been achieved through strong demand that followed a long period of deprivation.  These high levels of inflation has caused corporate leaders, business owners, and consumers to fear and worry that there is nothing ahead but significantly higher prices for the next few years.   As a result business leaders are acting in a defensive manner to prepare for this inflation by putting plans in place to raise prices for their products.  Likewise workers are demanding more wages to offset the inflation they believe lies on the horizon. This sort of thinking has caused inflationary expectations to become unanchored.  As this occurs it becomes challenging to re-anchor expectations for inflation back at low levels that are consistent with healthy economic growth without a recession and/or a sharp correction in asset prices. 

Inflation expectations have become unanchored resulting in fear driven behavior causing higher demand for labor and price hikes on raw materials, services, and goods. The actual Current Trends with inflation have been high and are still concerning.  We are experiencing acceleration in prices for oil, lumber, housing, and autos. Every major category in the CPI was up year-over-year except airline prices in the November 2021 report. In the commodity area corn, coffee, cattle, cotton, and soybeans, are all higher.  Conversely we have had some deceleration or lower prices for industrial commodities like steel and copper as well as precious metals. Even some Ag commodities like wheat have fallen.  The Baltic Dry Index (shipping price for raw materials) reveals a decline in shipping prices while containers for finished goods still remain at a premium.

We worry about this as well but believe that the financial system is healthy and sound and that the higher probability is for inflation to calm down as supply chain bottlenecks in the economy are resolved and modest hikes in interest rates are used by the Fed to push down exuberant demand, as I will explain further below.

Market Review

2021 was another great year for risk assets!  Real estate in general did quite well and stocks had an amazing year driven by over 48% earnings growth for the S&P 500. Single-family homes were up 14.5% on top of an over 20% gain in 2020, REITs were up 39%.  US Equities were up 20-30%, with the SP500 gaining about 27%, and the QQQ gaining 27%.  However the second largest economy in the globe had trouble and Chinese equity markets fell over 20% (FXI) as investors were caught by surprise by drastic change in economic policy by China’s ultimate leader Xi.

The MACM DYNAMIC GROWTH portfolio had great absolute return and was up over 22%.  This performance unfortunately lagged our bogey which was up 26%.  Our positions in Facebook, Apple, Netflix, and Google produced strong positive alpha for the portfolio along with positions in housing, restaurants and healthcare.  That 400 basis point underperformance versus the bogey (negative alpha or NA) occurred because Amazon unfortunately had an unexpected flat year of earnings growth because of tremendous expenses they incurred to add new capacity to their e-commerce division without notice to shareholders.  Further, investments in China and casinos held the MACM portfolio back as unexpected china driven problems occurred for Pro China investors.

Interesting to note that stock valuations (PE ratios) actually fell in 2021 despite better than 20% growth in prices.  This was due to the fact that earnings rose by over 48% for the S&P 500 resulting in a price-to-earnings ratio of 21 at the end of the year versus 23 at the beginning of the year. Growth has Outperformed Value in the Equity Market for 6+years and it doesn’t seem like that will change despite the pundits forecast of strong cyclical growth, and cheap valuations in Value sectors. Cyclical industrial value oriented businesses have been challenged in the environment we have today that favors healthcare, technology, and consumer oriented companies with secular tailwinds driving strong demand.  Real estate seems to be near all-time high valuations no matter how you measure it. Tremendous demand has been driven by life style choices, cheap credit, strong growth in wealth, as well as TINA (There Is No Alternative).

Risk assets have been highly valued because of Fed Policy, growth, and inflation fundamentals.  Valuations could well break if inflationary expectations accelerate. However, we think not or this is not on the immediate horizon as central banks are still expanding credit, economic growth is in the ideal zone of modest to trend like growth, and inflation is explainable.  However inflation is the wildcard and must calm down for risk assets to continue to rise.

Economic Review

  • Some Past Trends Changed.

We have had significant economic change in 2020 and 2021. The most notable is the fact that inflation and inflation expectations have heated up almost entirely due to the shut down and recovery of the Covid driven economy. Capacity bottlenecks started the problem and rising wealth has supported it. Further fiscal stimulus has brought about change in the labor force causing workers to quit at a record pace and they have been unwilling to get back to work without commanding higher wages.  Workers are attempting to unionize more and hope to gain more power in the workplace as a result of Covid.

The Federal Reserve’s policy of massive expansion of its balance sheet that came in response to Covid now seems to be over and the Fed’s current thoughts are all about re-anchoring inflation expectations without pushing the economy into recession.

Obviously we must recognize that the world’s second-largest economy has slowed dramatically over the last few years due to Covid but more importantly due to new policy of equality and socialism.  China’s supreme leader Xi has crushed a decade-long movement toward democracy and capitalism in China that enabled China to become an economic power.  It seems like China’s policy and goals for growth at all cost has been abandoned.  China’s growth has slowed dramatically affecting their trading partners and their demand for energy, raw materials, and finished goods. US exports to China have decelerated as well.

The energy sector has also embraced change. Carbon-based energy production has entered a managed decline that has enabled higher prices to exist as production has been minimalized by all players. OPEC is moving strategically and US players have been unable to increase output due to ESG (Environmental, Social and Governance) anti carbon pressure.  Overall carbon-based usage is in decline by many relative measures while other energy sources are rising.

  • Past Trends That Continued.

The US economy has been growing slowly in an ebb and flow manner for over a decade. We have experienced slow global growth with no great cyclical demand for industrial goods or services. There has been no overriding significant consumption themes in America.  Housing may well become a significant consumption theme going forward but it has yet to emerge into that.

The US economy has some Cyclical momentum from the rebound from the Covid 19 Shutdown. Retail sales are clearly in a strong uptrend mostly because of a rebound from Covid 19 deprivation as well as thick wallets because of higher wealth and stimulus money.  Autos and housing are strong and have momentum but still have not reached historic highs.  Travel and entertainment demand is high. The industrial sector is mixed with weak but improving global demand mostly due to the weakness in China.  Stay at home demand has waned impacting demand for single-family homes, home entertainment, computers, and home networking equipment.

We have several secular consumption  themes that remain in place but none are great consumption themes. The move to e-commerce continues but may be decelerating? Healthcare is still a priority and politically unobstructed.  Artificial Intelligence demand is growing but still a modest consumption theme. Cloud computing and digitization of data continues to be the most robust secular consumption theme. The related demand for technology is still high and growing.

Economic Outlook

  • Trends That Will Change.

The current high level of expectations for inflation will likely moderate as inflation finds its anchor allowing actual inflation to moderate.

The reasons why include:


  1. Bottlenecks ease.
  2. Excess $$ in the hands of consumers from fiscal policy dries up, causing

them to spend less and finally get back to work (wage + demand pressures


  1. Lack of significant (if any) new fiscal policy to replenish this excess $$.
  2. Surge in durables demand from covid slows as people have made all their

desired purchases, this demand returns to trend.

  1. Base effects recede (ie will autos increase 50% again y/y? and oil? not highly


  1. Fed tightening causes borrowing costs generally to increase and slows

demand, as well as decreases liquidity generally.


On the flip side, the primary risk to our outlook is that some or all of these changes

in trends fail to materialize. This seems like the less probable but still possible

outcome, and one which we’ll be monitoring closely.


Fed policy will become less accommodative but remain accommodative or neutral??  Rates will likely rise on Mortgages and CC’s by 100 bips or less.  The 10 year treasury trading range will rise to (1.5-2%).

  • Trends That Will Continue!

Carbon based energy production will remain in managed decline and will ultimately give way to lower prices, but higher prices may endure for a while as production is minimalized?

We continue to see Slow Global growth with no great cyclical demand for industrial goods? China was the great consumer for the last decade but has overbuilt and future demand will likely be modest.

It’s reasonable to believe that the US & Global economy will have cyclical momentum from the rebound from the Covid 19 Shutdown. Can this economic momentum be sustained?  Seems unlikely to be significant.  Retail Sales will moderate but stay in uptrend.  Autos and Housing consumption in US will stay strong but likely to decelerate with the 100 bip expected rise in rates.  Travel and Entertainment demand will accelerate as consumers want to get out and play.  Stay at home demand will wane impacting demand for: Homes, Home entertainment, Computers, home networking.  Secular consumption themes will remain in place as noted above.

Market Outlook

Equities and Real Estate likely to move to higher and establish new all-time high valuations.   Real Estate demand will continue to be driven by Lifestyle choices, cheap credit, strong growth in Wealth, and TINA. The return on equities seems to hedge heavily on corporate America’s ability to grow earnings again in 2022. Current estimates from street analyst call for earnings growth of 20% this year.  To do this corporate America will have to grow revenue and increase margins further in a difficult labor environment.  This could be challenging and remains the wildcard for stocks.  Stock demand will also be driven by high liquidity, and strong growth in Wealth.  Growth stocks will continue to outperform value stocks in the Equity Market as cyclical rebound hopes fade and rates stay moderate and tech earnings meet estimates. Cyclical Industrial Growth will remain modest making it challenging to own value companies that are growth challenged in the industrial, energy, and financial sector. This group may move for a while but the sustainability of this rally will require much higher rates, and stronger industrial growth, than is likely.

We remain cautiously optimistic for the economy and risk assets.