How Supply Chain Challenges and Inflation Will Impact the Stock Market

NYSE: SPY | SPDR S&P 500 ETF Trust News, Ratings, and Charts

SPY – One of the central themes of the past few months has been inflation. It is also a significant theme as earnings reports continue to file in. One of the biggest questions ahead of earnings season was how supply chain challenges and inflation would affect corporate margins. The answer is, so far, so good. But should we be concerned with inflation and its effect on the S&P 500 (SPY) going forward? I’ll discuss this and more below….

(Please enjoy this updated version of my weekly commentary published October 27, 2021 from the POWR Value newsletter).

As markets continue to hit new heights, one concern lurking in the shadows is inflation. Last year, many market “gurus” predicted that inflation wouldn’t be an issue. But it is undoubtedly a reality now. While it may be transitory, I do expect it to last into next year.

The question right now is how long does transitory really mean. Fed Chair Powell has even recently noted that inflation might be stickier than previously forecasted. In fact, he recently commented, “Supply-side constraints have gotten worse. The risks are clearly now to longer and more-persistent bottlenecks, and thus to higher inflation.”

This comment was made during a virtual conference last week with the Bank of International Settlements. In essence, he is conceding that inflation may remain hot a while longer. But, keep in mind, he didn’t say that inflation is here to stay. It is still transitory but over a more extended period. He also noted that the Fed was on track to begin to taper asset purchases.

While his comments on inflation may be nerve-wracking for some investors, we need to understand that the fundamentals of the global economy don’t support sustained inflation. Inflation happens when consumer demand is higher than the productive capacity of an economy. So, let’s take a look at how inflation is affecting the economy right now.

The big one, as I have mentioned, is supply chain backlogs. These continue to build up as labor and material shortages have become an issue for businesses. This has led firms to raise prices. Inflation has also become an issue for oil. U.S. West Texas Intermediate crude oil prices recently topped $85 per barrel, the highest level since 2014. There is no doubt higher oils prices are impacting us at the pump.

Filling up your car is much more expensive now than during the height of the pandemic when I was able to get premium gas for less than $2 a gallon. In addition, the benchmark 10-year Treasury yield has been hovering around 1.6% due to inflationary concerns amid higher energy and commodity prices as well other price increases. It has also affected housing.

Housing starts, which are released monthly, show the number of privately owned new houses on which construction has begun in a given period. Housing starts recently fell 1.6% to its lowest level since April.

The rate was actually expected to rise, but supply chain disruptions are weighing on housing starts, as the costs of raw materials such as lumber are rising. In fact, our ports are all clogged up right now with ships waiting to unload.

So, while supply chain bottlenecks and labor shortages have led to higher prices, we are still in pretty good shape. Some companies are starting to increase their workforces, and there is also a massive labor pool ready to come off the sidelines once their savings start dwindling. In addition, automation may help with increasing productivity.

Plus, as I mentioned in previous commentaries, I expect these issues causing higher prices will get sorted out over time. I suspect that the pent-up demand that we have seen will normalize. In terms of the market, stocks have been supported by another strong earnings season.

While some executives have mentioned the effect of rising costs on their profit margins, revenue growth has been so strong that many companies have been able to absorb the higher costs.

We have so far seen strong earnings surprises from companies in different sectors, including financials, tech, and health care. While there may still be some volatility ahead, I don’t expect a significant drop over the near term. In addition to a strong earnings picture, lower cases of the Delta variant of COVID also bode well for market performance through the rest of the year.

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All the Best!

David Cohne
Chief Value Strategist, StockNews
Editor, POWR Value Newsletter

SPY shares were trading at $457.23 per share on Thursday morning, up $3.29 (+0.72%). Year-to-date, SPY has gained 23.49%, versus a % rise in the benchmark S&P 500 index during the same period.

About the Author: David Cohne

David Cohne has 20 years of experience as an investment analyst and writer. Prior to StockNews, David spent eleven years as a consultant providing outsourced investment research and content to financial services companies, hedge funds, and online publications. David enjoys researching and writing about stocks and the markets. He takes a fundamental quantitative approach in evaluating stocks for readers. More...

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