Equities and risk assets experienced heightened volatility in the third quarter but managed to log yet another positive return of +0.58% for the quarter. Strong earnings results, a dovish Federal Reserve, and a strong US consumer base were large positives for the markets. On the flip side, debt ceiling concerns, intra-party disagreements over Democratic priorities, slowing economic growth, an overly leveraged Chinese real estate market, and inflation worries caused some jitters in financial markets.

Strong earnings results were heavily supported by consumers ongoing willingness to spend despite inflationary pressures. In aggregate, US consumers are coming out of the pandemic with a much healthier balance sheet and record net worth. A surging real estate and stock market coupled with fiscal stimulus support created an unprecedented increase in wealth for US households and non-profit organizations. In the last 12 months ending June 2021, total household and non-profit organizations added $23 trillion to their total net worth, a 19.55% increase. Comparatively, total net worth increased by $20 trillion between 2016 to 2020, a 21.78% increase.

Simply put, households and non-profit organizations added more wealth in the last 12 months than they did in the preceding 5 years. Such positive wealth creation translated into higher consumption, leading to heightened demand, and adding additional pressures on global supply capacity. To illustrate the strength of the US consumers, year over year change in retail sales data have increased by more than 10% every month this year, recording one of the best stretches for retail sales data in history. Existing levels are far exceeding 2019 levels when the economy was at full employment with a well-functioning supply chain.

As consumer demand remained resilient, businesses experienced difficult times with restocking its inventories in an already stretched and fragile global supply chain due to covid disruptions. Although the US ISM Inventories Index came in at 55.6 in September 2021, indicating an expansionary environment for nominal inventories, the Business Inventory to Sales Ratio declined to 1.26x, below its long-term average of 1.40x. This is an indication that sales are currently outpacing restocking efforts, a positive development for many businesses that is translating into stronger earnings results. Despite this stronger environment, businesses are warning of margin pressures in future quarters as higher consumption are exerting strains on supply capacities, creating an upward pressure on price inflation. Should companies pass on higher prices to consumers, the sustainability of heightened consumer demand may become a concern as consumers could potentially scale back on their purchases. However, early indications do not suggest that this is happening, and consumers continue to spend despite recent price increases.

Rising prices are a function of rising input cost inflation for many companies. For service-based businesses, it is wage growth inflation that are primary costs for margin pressures. Aggregate wage growth increased 4.51% year over year, but the largest increases are occurring in industries that were most affected by the COVID lockdowns like leisure, hospitality, retail, and education. There are still close to a million less workers within these industries post-COVID relative to pre-COVID which are causing labor shortages and increased wage pressures. Health concerns, additional family responsibilities, better job opportunities elsewhere, and discouraged workers are among factors contributing to these shortages. In contrast, the IT sector which typically leads all industries in wage growth is experiencing the least wage growth pressures in 2021. This could partly be explained by the fact that the Information sector was least economically affected by the COVID pandemic.

For product-based businesses, shipping and commodities costs are exerting pressures on input costs. Shipping container costs from Asia to North America have increased by fivefold since last year despite efforts by global shipping competition agencies and commitments by some carriers to freeze rates. Rates for a 40-foot container are going for over $20,000 today when it was $4,500 this time last year. Increased demand for consumer products like electronics, appliances, and automobiles that are usually produced in Asia spiked during the pandemic and continued to increase as economies re-opened after lockdown measures were lifted. This surge in demand resulted in higher shipping rates for containers coming out of Asia. Additionally, a combination of labor shortages, congestions, vessel delays, and equipment shortages have compounded underutilization of container capacity which are also causing disruptions and upward pressures on shipping rates. Rates are likely going to remain high so long as consumer demand for goods remain robust. With peak Christmas season coming up in the US, we do not expect high shipping rates to come down anytime soon.

With oil prices up 80% year-to-date, a wide variety of products ranging from plastics to fertilizers have been affected by rising costs. After experiencing severe disruptions at the height of the pandemic, with negative prices at one point, oil markets are now experiencing prices not seen since the fracking boom in the mid 2010’s. A large contributor to higher oil prices have been a combination of increased demand and limited supply as economies re-opened while oil production remained below pre-COVID levels. For example, new US oil rig count is currently a little over half of what it was at the end of 2019.

Furthermore, the focus on renewable energy and investors’ aversion to the fossil fuel industry is causing some of the oil majors to cut back on their capital spending and instead, opting to use their strong cash flow to buy back shares and pay out dividends to lure back investor interests.

With the lack of substantially higher oil production in the near-term, we expect oil prices to remain above its 3-year historical average. This will likely induce a more persistent inflation outlook and one that bears monitoring.