On January 20, 2022, Sand Hill's Chief Investment Officer Brenda Vingiello, CFA, joined the CNBC Halftime Report panel once again to discuss recent market volatilityread more
Living in the Age of Uncomfortable Change
November 2, 2021
During the last several decades, the world benefitted from considerable positive change as the advent of the internet, smart phones, and immunotherapies—to name a few—altered the way we did things and made our lives easier. Ironically, this may have contributed to making the last two pandemic-impacted years feel so unsettling. If there is one theme that could characterize this relatively short period, it would be uncomfortable change. Even though this current environment will likely have multiple silver-lining outcomes—from better work-life balance, to increased ability to rapidly create life-saving medical therapies and vaccines, and less general reliance on fossil fuels—the initial stage to get to that improved end-result has been anything but easy.
When the pandemic began, we were forced to change the way we lived our lives by dramatically limiting our social interactions, wearing masks—which is not common in Western culture—and, ironically, adopting the latest technology whether we were ready to or not. This tension was compounded because many people made life and career altering choices that were driven by rather extreme concern for their own health and that of their family; and companies made tough, long-term decisions as the pandemic-driven disruption dragged on.
When 2021 began, we were all longing for the day when things would be back to normal. As we assess the environment today, we have a lot to be thankful for as vaccines have changed the course of the pandemic, the stock market has rebounded and reached new record highs, and more flexible work arrangements are here to stay. These could absolutely be categorized as an improvement to the “old normal”. Yet not everything has returned to the way it used to be. In fact, some things seem to have gotten worse over time. Ongoing supply chain disruptions have led to shortages and higher shipping costs, and supply/demand imbalances within many parts of the commodity complex are also contributing to inflationary pressures. While some of this inflation will likely be transitory, the timing of such price increases returning to pre-pandemic levels remains uncertain.
In our view, supply-chain-driven price increases are likely to prove temporary, although they may persist for several more quarters. Last year, stronger than expected demand for goods took global supply chains by surprise, and they were already grappling with pandemic-driven labor shortages and port shutdowns. Even as the economy began to slowly reopen, demand for goods stayed high. According to BCA Research, spending on consumer durable goods was 27% above pre-pandemic levels in March of this year. By August, it had declined, but it was still 8% higher than its normal trend. Supply chains have remained strained, and the Delta variant led to another round of turmoil at ports and factories around the world. With the Federal government stepping in to try to help ease congestion at the nation’s busiest ports, there is some hope that this impact will subside over time. Yet, the complexity and trickle-down effects of the disruption will be difficult to remedy quickly. Nevertheless, we expect financial markets will likely react favorably to news that this gridlock is at least beginning to dissipate, even if it does take a long time to return to pre-pandemic levels.
Disruptions taking place within the commodity industry are trickier to solve and could cause price volatility for some time to come. Prior to the pandemic, much of the fossil fuel industry was suffering from a lack of investment, particularly following the oil price decline that took place in 2015. This lack of capital has been coupled with the variety of competing company stakeholders that management teams now answer to, including activist shareholders and board members that have been dissuading companies from investing in further production in favor of developing more renewable energy capacity. By many measures, this is all a necessary transition, but the complexities of managing the global supply of fossil fuel are starkly coming to the forefront as this transition evolves.
In addition, during the height of the pandemic, inventories of many commodities rose significantly as economic activity declined. This further discouraged companies from investing in growing production. As the world has reopened and demand has increased, these inventories have now been depleted, making various industries more susceptible to even modest disruptions. Yet, we are now in a global environment where the adage that the cure for higher commodity prices is higher commodity prices may no longer ring true as companies and boards are more focused on shifting production to renewable energy sources. This has the potential to result in a period of prolonged supply/demand imbalances that may not be as temporary as we would like them to be. The International Energy Agency (IEA) estimates that renewable energy sources will generate 20% of global energy production by 2030, up from 12% in 2020. However, the IEA also forecasts that by that time the global economy will still need about 5% more oil and natural gas than it consumes today.
This environment has given us greater conviction in the overweight position in commodities that we established for our clients over the last year. When we first added to commodities in April of 2020, it was an unpopular investment. Yet, we felt that markets would normalize and that forward oil prices—which were astonishingly negative at the time—would likely recover. We also recognized that under-investment in the fossil fuel industry would likely result in a favorable supply/demand environment when the global economy began to reopen. Furthermore, the global shift to renewable energy also supports an increase in demand for industrial metals that are needed to build out the necessary new infrastructure.
Even though rising prices represent another uncomfortable change, the pieces may be in place for the global economy to manage through this period. Corporate profitability is at an all-time high, which suggests that companies could manage through a higher interest rate environment that is driven by an improving economy and modestly higher inflation. Furthermore, many of the largest companies in the S&P 500 have significant pricing power and would likely be able to pass higher prices along to their customers. Consumers’ balance sheets are also very healthy as savings are high, debt payments are low (as a percentage of income), and wage growth is increasing. All these factors should, in our view, help consumers manage through a period of higher-than-usual inflation. As usual, though, we are closely monitoring this evolving environment and plan to make changes to our clients’ portfolios to protect and grow capital should we feel it is warranted.
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