Trick or Treat

by | October 18, 2021

This past week, investors were treated to the delight of a strong start to the third quarter earnings season. Led by financials, equity markets have advanced over 4% in the first two weeks of October. Yet as every child knows, this month ends with Halloween, a time of ghosts, goblins and other frights emerging from the shadows. 

For investors, the final weeks of October are likely to deliver more earnings treats, but the sugar high may not last much beyond Halloween. What follows could be a genuine ‘trick’, characterized by persistent supply chain shortages, rising costs, higher inflation, and unwelcome central bank responses. Surging profits are great for now, but the underlying news flow is not as positive as the markets’ giddy October reaction suggests.

To be sure, surging share prices in response to higher earnings is understandable. Corporate profits are expected to rise nearly 30% year-on-year in the current reporting season, following even stronger gains in the prior two quarters. Historically, whether measured top down (profit share in GDP) or bottom up (return on equity of listed firms), company profitability is at or near record levels.

Yet surging profits is not the only story making headlines. Supply chain disruptions are proving to be more widespread and enduring than most observers thought possible only a few months ago. On investor calls, CEO and CFO mentions of such bottlenecks are running well above the average of the past decade. In the UK, profit warnings are up over 250% in the current reporting season, with over 40% of companies citing obstacles in procuring inputs, delivering shipments, finding workers, or footing the bill for higher energy prices.

Disruptions to production and delivery are becoming larger macroeconomic and even political issues. While long-term market measures of inflation expectations remain within ranges that don’t normally alarm central bankers, some of their own surveys of households and businesses are beginning to tell a different story. For example, the New York Fed‘s survey of consumer expectations indicates a sharp rise in anticipated inflation over the next 12 and 36 months. Notably, three-year ahead consumer inflation expectations have risen from just over 2% one year ago to over 4% today, their highest reading in more than seven years. 

While acknowledging the limits that central banks face when addressing supply-side shocks, Bank of England Governor Martin Bailey nevertheless noted this weekend that ‘it [monetary policy] will have to act and must do if we see a risk, particularly to medium-term inflation and medium-term expectations.’ 

Restoring employment and output from the severe pandemic recession is now being called into question as the sole or even primary objective of monetary policy in some central banking circles. That ought to concern investors willing to project steady growth and strong earnings well into the future.

Rising costs, empty shelves, and delays in deliveries may also exact a political toll. President Biden recently brokered a deal between unions and businesses to open US west coast ports 24/7 to alleviate a backlog of ships waiting at anchor to offload their cargo. But a stagnant labor force participation rate, as well as increasing union agitation and strikes for higher pay, are testimony to the fact that bottlenecks are not isolated. It is increasingly apparent that they span global and domestic markets, and include the spectrum of delivery of goods, services, and labor. The problem of supply-side pinch points surely does not originate in Washington (or any other seat of government), but if barren shelves result in unfulfilled Christmas wishes, it would hardly be surprising if incumbents didn’t pay a political price in 2022. 

From an investor perspective, it is unwise in the short run to fight earnings momentum. Positive profits results in forthcoming reports from information technology, energy, and healthcare companies, will keep investors engaged in global equities over the next few weeks. But the news about shortages, rising costs and higher inflation and inflation expectations cannot be easily dismissed. 

By Halloween, the earnings season will have largely run its course. The good news will be reflected in higher valuations. The same cannot be said for stories about rising costs, persistent inflation, or widespread shortages, as well as the risks they pose to the hitherto welcome stance of monetary policies or to the outlook for global growth.

Halloween arrives on October 31. Enjoy the treats while they last, for it could get scary after that.

Filed Under: Featured

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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