BofA with the note. I agree with the conclusions:
A different asset allocation is warranted depending on what you believe about inflation and its effects.
1. Transitory and good: on this view, the good news about“bad” prices is that those prices are a sign of a faster-than-expected economic rebound. Temporary frictions can be resolved, and faster growth with low risk of a price spiral should benefit cyclicals like financials and floating-rate & lower-rated credit.
2. Transitory and bad: on this view, hopes for a fast and furious reopening prove ill-founded. The future return to a cooler, “secular stagnation” economy would mean that any selloffs in mega-cap, deflationary tech& IG credit should be bought aggressively.
3. Permanent and good: on this view, modestly higher wages can create more incentives for companies to expand capacity and boost productivity, with positive-sum effects on the economy. Since many firms enjoy pricing power and record-high margins, they can afford to invest for the future, so investors ought to own industrial companies, advanced materials and other resources.
4. Permanent and bad: investors who remember the 1970s & 80s know that uncontrolled inflation can do real damage. Investors who believe in a serious risk of repeating that era likely already own TIPS, gold, and other real assets, or ought to.
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We believe the first scenario is the most plausible, and then the third. The good news about bad prices Michelle Meyer and her team expect core PCE inflation, the Fed’s preferred measure, to peak at 2.3% this quarter, before settling back down to 1.9%by the end of 2021.
In 2020, many firms cut capacity and reduced inventories, expecting a long recession. The faster rebound has meant shortages in lumber, corn, copper, etc. Some bottlenecks may lack quick fixes (e.g. semiconductors), but many others can be resolved.
There are also good reasons to think that any sharp surge in wages will end by Q4. Labor supply is set to rise sharply. Generous unemployment insurance benefits expire in September, children will return to public schools, health concerns will be alleviated, and firms will be able to hire from a broader pool of remote workers. We have 9.8 million unemployed workers and our economists expect an additional 2mm+ returning to the labor force by the fall.
Neither is there any sign of excess demand. The latest BofA consumer data confirms our “fiscal liquidity trap” thesis.
•High-income households have excess savings, but history shows they don’t spend; and a chill in high-income spending is more likely in 2021 from the threat of higher taxes (Ricardian equivalence);
•Low-income households received excess stimulus but their spending has already peaked and <10% of new rounds of stimulus are being spent.