Inflation: Navigating the Threat

By Bill Studebaker, CIO & President, ROBO Global

 

The commitment to inflation targeting is still alive and well, but the Federal Reserve is now more reliant on ‘realized data,’ choosing to hike rates not when they predict inflation is coming, but when they see evidence that it has already arrived. We’re not there yet. Nonetheless, inflation is viewed as the single biggest risk factor in the markets today. The result: as forward inflation metrics continue their upward trajectory, investors are actively seeking paths to reliable growth. One place they may find it is in the more direct plays, including in companies and segments that are less affected by rising costs, and in robotics and automation technologies that boost productivity.

To take that a step further, let’s dig into the numbers for a minute.

As hot as the June Consumer Price Index (CPI) data looks, it has actually cooled a bit compared to the May data. That's not what the Fed wants to see. Considering the fact that the May data is measured off the very bottom of the pandemic, the change is not significant. A year ago, in the thick of the pandemic, the CPI was trending at 4.9%. Today, the year-on-year CPI is 3.1%.1 According to the Fed’s ‘optimal control’ approach (Janet Yellen’s policy brainchild), that number is above-trend to compensate for prior deflation. But the trend itself is below target from the Fed's point of view, so inflation may need to run hotter and longer before the Fed decides to raise interest rates.

That fact doesn’t wash away concerns about inflation. It is something investors should monitor carefully. For example, restaurant utilization, which many predicted would never recover, is already exceeding pre-pandemic levels across the US. Some may argue that this sort of trend points to a brief, transitory burst of inflation, but other indicators suggest a different outcome. Capital goods orders, also a precursor to growth, have also broken out to reach historic highs. This earnings season is the fourth record-setter in a row. The upgrade rate of forward earnings has been elevated all year and is now at a near-record, reflecting a cyclical recovery combined with the emergence of a productivity boom driven by automation. Lastly, the business inventory/sales ratio is near the tightest in history, almost tying the all-time low set in 1950 at the dawn of the post-war boom. (While inflation was somewhat high in 1950, real GDP growth at 13.4% was by far the strongest in history.) These indicators could suggest a similar outcome in the wake of the global war against Covid-19.

Make no mistake about it: we are experiencing the leading edge of a productivity wave. Gross domestic product is quickly returning to its pre-pandemic highs—with 7 million fewer workers producing goods, and 18% of them working remotely.2 That is, by definition, a step-function upshift in productivity (and an achievement that wouldn’t have been possible without the aid of robotics and artificial intelligence). However, given the wind-up in inflation expectations and concern for ultra-rich growth, investors must think more prudently about where to invest. Though the debate continues about precisely where we sit in the cycle, we do see capital expenditures driving the next leg of growthThis positions the ROBO Global Index in a favorable position, especially given the fact that the factory automation cycle bottomed in 2Q20, and we are now only one year into an upcycle that typically lasts 3 years or more.

For investors seeking growth in the face of pending inflation, now is the time to keep an eye on valuations of high-growth companies, closely watch interest rates and inflation that could negatively impact those valuations, and focus on companies that pose less interest-rate risk. We believe it is also an ideal time to invest in robotics, automation, and AI. As companies strive to succeed in a post-pandemic economy, controlling costs and increasing margins will be a primary goal. The ROBO index includes many of the most important robotics and AI companies that are enabling factory automation to come roaring back and companies to reposition for post-pandemic success. These companies have also demonstrated strong pricing power in periods of raw-material inflation (as we saw in 2013-2014), and we expect this trend to continue. Investors who invest to capture that acceleration today may be rewarded in the future—regardless of which way the inflation winds blow.

 

This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

 

1 Source: Trend Macro

2 Source: Trend Macro

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