Eric Lascelles:
Hello, and welcome to our latest video #MacroMemo. There’s much to cover off this week.
We’ll talk, as always, about the latest COVID figures, which appear to be peaking in many parts of the world. We’ll acknowledge some economic deceleration and get into the details there as to why it’s happening and the outlook for the future.
And then we’ll also diverge into a few other specific thematic topics. And so, one is, some Asian manufacturing challenges with reference and relevance to the rest of the world. We’ll look at inflation, as we always do, and it looks increasingly credibly like it’s peaking, which is something that we’ve been claiming for a while and feel more confident about after some recent data points. We’ll talk about chip shortages, which is a key influence on inflation. And we’ll finish with a Canadian election preview, which, as of this recording at least, is about a week away.
Let’s start with COVID. And so, globally I can say quite happily that the numbers are getting better. There are fewer global infections. There are fewer global fatalities as well. And whereas initially it was emerging markets that were mostly getting better, it’s also developed countries that are, on average, improving as well.
It’s not every country. The UK numbers, for instance, are still getting a little bit worse. Canadian numbers are in the realm of peaking or plateauing right now, with some flatness visible in Ontario, BC, and Alberta.
But we are getting a lot of countries that are actively improving at this point in time. And the U.S. leads the charts, I suppose. And so the U.S. numbers most definitely improving at this point, having gone from almost every state deteriorating just about a month ago to fewer than half of states deteriorating. More than half getting better, that is to say. And even places like Florida, which were among the most challenged states, now seeing a significant drop in infections and in hospitalizations as well.
And in terms of why that’s happening, it’s still an open question. It seems to be some mix of people behaving more cautiously voluntarily; some mix of people having been vaccinated; others having some level of natural immunity, having been infected as well. But the combination seems for the moment to be holding.
I would say there’s still an open question for the next few months. The extent to which colder weather, reopened schools help to get the virus circulating more again. We’re hoping not but there is a risk there. But for the moment, the COVID file actually is broadly improving as opposed to getting worse.
And we can see a little bit of economic damage emerging from that. We look at the Beige Book, which is an anecdotal report of U.S. economic activity, and it does show some deceleration of economic growth into the late summer. It acknowledges a decline in eating out and in tourism and the sorts of things that are high touch that you would perhaps avoid if a little more concerned about the Delta variant.
And also, we see corporate reports that are citing a surge in demand again for things like toilet paper and paper towels, which is something that was experienced during the first wave. And so, some people are hunkering down and socializing less, and there’s a bit of economic damage that comes from that, as much as it’s also likely helping to limit the spread of the virus right now.
When we look at the economic picture, we can see some economic data continuing to soften. The surprise indices are broadly negative right now, meaning the winning bet more often than not is a below-consensus outcome as opposed to an above-consensus outcome.
And some prominent forecasters out there have now been cutting their very near-term growth forecast. It looks like the third quarter in particular might not see quite as much economic growth as previously assumed. I should note, we’ve been below consensus in our growth forecast for a while, so this is mostly the market catching up to us as opposed to us obliged to move further. And I should also emphasize, the pain shouldn’t be all that long lived in the sense that, as we see these infection numbers start to come down in places like the U.S., we probably see the economy start to revive again.
And beneath the surface, as much as the economy isn’t moving quite as quickly as before, companies still want more workers. That is undeniable. Job openings are still at a record high. It’s more a function of getting people willing to fill those roles.
I can say, similarly, from an economic standpoint, that household finances still look quite good. Households have saved quite a lot of money right across the developed world. And a disproportionate fraction of that is still sitting in things like chequing accounts and savings accounts and money market accounts, and so could fairly easily be deployed if so desired. And so, there is absolutely economic upside to come but I do think the period of extremely fast growth has perhaps come and gone.
On the subject of Asian manufacturing, which isn’t something that gets a huge amount of attention, but maybe it should to the extent that’s where many of the things we all buy come from. I can say that manufacturing indices for Southeast Asia in particular have been softening over the last few months. They are now in fact firmly in contraction mode. And so, this is seemingly in large part because Southeast Asia had dodged prior waves of the pandemic quite significantly. They’ve been hit fairly hard this go-round, and so the sorts of restrictions that limit economic activity have also limited manufacturing in those countries. And indeed, we’ve even seen outbreaks in some factories that have required them to be temporarily shut down.
And so the bottom line is, it’s getting a little harder to get certain things. Chinese manufacturing PMI also fell into slight contraction as well, so China also in the mix on this subject. And so, as we look to the future, I guess the question would be whether this persists. And so, some countries are now getting better; we see their infection rates coming down. Others are not yet, including Vietnam and the Philippines. And so it’s going to take some time to work through this.
I guess the point would be, we’ve tended to think of supply chain disruptions as being disproportionately people on our side of the equation changing their demand for things and shipments being constrained by a lack of ships and containers and these sorts of things. And those are still true. But equally, there is a supply issue also on the manufacturing side in Asia. And so, from all of those perspectives, it’s going to take some time to work through these issues. Inflation likely stays at least a little bit elevated in the meantime.
Now on the subject of inflation, let’s just acknowledge that inflation remains quite high. And so that is very much true and it’s the most notable observation about inflation right now. But we do believe it is in the process of peaking. And indeed, recent data points suggest that’s the case. We just got an American CPI print, and it was considerably less hot than most of the last six to nine months. The monthly change was plus 0.3%. That’s not a cool number but it’s less hot than before.
We can look at other measures of inflation like the PCE deflator, and it’s been coming off a little bit. We can look at producer prices, and they’re still rising quickly but they’re rising a bit less quickly than they were over the prior few months. And we notice that surveys of manufacturers and service companies report that their own prices paid for their inputs are a little bit less hot than previously.
So we think we’re working past peak inflation but we don’t think we’re going immediately back to normal inflation, in part for the supply chain issues just discussed; in part because there are quite considerable chip shortages as well.
On the subject of chip shortages, well, why are there chip shortages? Why is that an acute problem? And I should start by saying, it’s not that computer chips are a huge part of the cost of something like a car; it’s a fairly small part, but you do need them to make the car. And so to the extent that chips just aren’t available, the items, the cars in this case, just can’t be made. And so that’s the pinch point, and that’s why we’re seeing high inflation in a lot of things that use chips, even though the cost of the chip itself isn’t overwhelmingly a large fraction of the total.
In terms of why there is this chip issue, well, there’s been a supply-side and a demand-side story. The supply side is one in which the supply of chips initially fell at the start of the pandemic. There’s a history of boom and bust in the industry and so chip fabrication plants slashed their production when the pandemic struck because the economy was temporarily so weakened. We saw carmakers in particular cancelling their orders. We’ve also seen some illness of workers in the plants which has also affected supply.
And so, supply went down. Demand, though, went up. It actually surged because people needed computers for virtual work and for virtual school, and of course, it all lasted longer and has lasted for longer than people had initially imagined. People ended up wanting more cars as opposed to fewer cars because there’s an aversion to public transit given the pandemic. And so, it’s going to take probably years to resolve this mismatch.
It takes two to five years to build a new chip fabrication plant. Even just to upgrade an existing plant is quite a considerable effort and something that has to happen every 18 months to 24 months. And so there’s a lot of investment that needs to occur to keep this going. In the meantime, the backlog only grows longer, and major chipmakers are now announcing fairly significant price increases as well of 10 to 20%.
So, the bottom line is, this chip shortage probably isn’t resolved in the near term. It’s likely going to stick with us for a while, and that will keep the cost of certain things elevated in the meantime.
And let me finish with a discussion of the Canadian election that is scheduled for September 20th. And so polls show a very close race between the Conservatives and the Liberals. I’ll focus on those two parties as a result. The models say that the Liberals probably still win a minority, which isn’t what the Liberals had hoped for. They were hoping to turn a minority into a majority outcome, but that’s looking less likely at this point in time. Of course, there is still almost a week for these things to change, I should emphasize, but that’s where it sits right now.
The models suggest the Liberals are more likely to win, not because they’re likely to surge in the polls, but because they have a better distribution of votes such that they’ll get more seats even if they have a slightly fewer number of votes, which happened two years ago and, again, netted the Liberals a win. Nevertheless, it could still go either way.
And I guess a few comments in terms of the policy platforms. At the highest level, I can say the promises are quite expansive. Both parties are making enormous numbers of quite generous proposals, in significant part that would expand the government. In terms of why we’re seeing all of these proposals, well, to some extent, it’s the norm of elections. But beyond that, the pandemic isn’t fully resolved so some proposals are specific to helping that process along.
I would say the last few years have normalized, to an extent, huge government actions. And so, from that perspective, we can say that government’s just thinking big these days. And then simultaneously, interest rates have remained extremely low and so no one feels particularly constrained by debts or deficits or anything like that. No one has a small government proposal in this election.
And so, I can say everyone is proposing big ideas, and everyone has shuffled, it seems to me, a step or two to the left in the political spectrum as well. And so, the Liberals would continue with their existing programs of pandemic support for the most part. The Conservatives have their own suite of pandemic proposals. They would have a more generous employment insurance program, and they would subsidize the salary of new hires temporarily. And they propose a refundable loan to small businesses, and they also propose a GST tax holiday for December and a program of subsidizing restaurant dining for a month as well. So all sorts of proposals on the Conservative side. The Liberals’ programs are already largely in effect on that front.
The Liberals are very much envisioning an even bigger government than before. So they’re proposing more money for seniors through Old Age Security; more generous provisions for student loan support; more money for low-income workers; a new saving program for people looking to buy their first home; more money for the health care; big childcare program; major green initiatives. And, as has been detailed as well, a tax on big banks and insurers. So all sorts of big plans there.
The Conservatives also have big visions. And so, they’re much more centrist than in the past, meaning less right leaning. Also more money for low-income workers; also programs to help home buyers; also more money for health care. Smaller childcare program. Significant green initiatives, though probably not as comprehensive as the Liberals. Both parties, by the way, making all sorts of infrastructure promises.
What’s interesting, though, on the Conservative side, are some things we don’t normally associate with the Conservative Party. And so, for instance, they’re proposing to put worker representatives on the board of directors of federally regulated companies like banks and insurers and telecom and these sorts of things. That’s a fairly radical proposal. They propose to make it easier to unionize in certain situations for workers, which is not something we hear from the Conservatives too often. And then, more traditionally, pro-market, pro-innovation policies, including allowing foreign competition into the telecom sector, including creating a 5% capital investment credit. And so, those are kind of more traditional pro-business or pro-productivity measures.
At the top-down level, the differences aren’t enormous. The Liberals propose $78 billion of new spending over the next five years. The Conservatives, a bit less; it’s 51 billion.
From a deficit perspective, the difference is even smaller. Five years from now, we can say that the Liberals propose a deficit of $32 billion; the Conservatives propose one of $25 billion. And so, the Liberals are a bit more expansive in general, but nevertheless, significant deficits persisting fairly far into the future for both parties.
In terms of implications of all of this, well, it’s probably a minority government one way or the other. The Liberals could probably do a fair amount of their agenda, given the natural allies they possess. If the Conservatives win a minority, it would be more difficult, more restricted; they don’t have as many natural allies in Parliament. But many of their proposals might be favourably received by the other parties to the extent they are fairly progressive.
In general, we can say markets prefer right-leaning governments. But I should emphasize, this particular iteration of the Conservatives is not the pro-big business Conservative Party of days gone old, and so that statement is probably a little bit less true than in the past. And, for that matter, the U.S. experience over the last five years shows that markets can do very well indeed, whether led by a populist right-leaning president in the form of President Trump or a fairly left-leaning president in the form of President Biden. And so, politics don’t always map directly onto the economy or markets.
Okay. I’ll leave it there and say thanks very much for tuning in. I hope you found all of this interesting, and please consider tuning in again in the future.