Bombarded by stories from the 1970s in the news media and watching the geopolitical developments around us, it is very difficult for someone to be optimistic on how inflation can drop next year. However, there are already many signs around us, what we call leading indicators, which point to a light at the end of the tunnel in just a few months from now. Housing prices, raw materials, transportation costs, consumer goods such as electronics and apparel have already shown the first signs of price declines. Wages and Rents are two categories which continue to cause concern, but there are some visible improvements there too. According to the US Small Business Survey, the share of companies planning to increase prices is now the smallest since January 2021 and labor compensation plans have also started to ease. The US housing market is already in recession and rents should follow home prices down in the coming months. Of course, one of the big unknowns is how energy prices will evolve during winter, but again, those are already down significantly from their summer peak.
In this special report we present a few charts of various leading indicators which point to a brighter picture ahead perhaps.
World Container Index
After the surge during the pandemic and until the summer of 2021, the cost of transportation has collapsed. The World Container Index remains almost double what it was during 2016-2020, but is has dropped more than 70% since the peak of last September. This has significant implications for the cost of goods, which means that eventually companies will be able to pass lower prices to end-consumers, especially as demand is starting to weaken, due to the interest rate increases by central banks. At the same time, as inflation is a comparison of prices between the current month and the same period of the previous year, the transportation sub-index in the CPI report will start showing significant negative contributions in the next months,, if the cost remains around current levels.
Industrial Raw Materials
The below chart shows the price of Aluminum, which is down 45% since the peak in April. The same trends hold for most widely used industrial materials, which are already down 50% and more in some cases , in the same period. Copper is down 30% and Iron Ore down 70%, to name but a few. Again, we have to admit that prices remain higher compared to the prepandemic era, by at least 50%, but the fact that they have deflated so much from their recent highs should soon spill into the rest of the economy , bringing down the cost of manufacturing and construction. Even the semiconductor prices are significantly down as supply chain issues have been resolved to a great extend and 2022 demand has not kept up with the rush of the companies to boost supply in 2021.
Used Car Prices
Used car prices skyrocketed in 2020 and even more in 2021 as the supply chain issues and the lack of specific materials and auto parts caused huge delays in the deliveries of new cars. It became almost impossible to buy a new car as the sudden rush into electric vehicles as well as the need for commuting more safely during the pandemic caused a big spike in the demand. However, in this case too, we see that prices have peaked in January and have stabilized at lower levels since then. The improvement in supply chains as well as the drop in demand caused by the much higher interest rates on car loans than one year ago, should cause prices to drop further in the coming months. Yes, prices remain very high, but as we have mentioned many times before, inflation is a rate of growth, a rate of increase between two points in time. The contribution to inflation has already been negative as current prices are being compared to the same period of last year, which were close to the historic highs.
US Housing prices
Last month we had the first monthly drop in the S&P/Case-Schiller Price index after many years (shown as a small blip at the top righrt corner). The increase in home prices for the last 10 years looks like the period between 1996-2006, with similar steep gains. Interestingly back then, the housing market peaked two years before it produced the 2008 crisis, with falling home prices causing many defaults and foreclosures. Then home prices were in a downtrend for almost 5 years (red circle). With mortgage rates at 7% and the NAHB index at a two year low, maybe one can conclude that we are ahead of another multi-year decline of house prices, in the US primarily. This will be a significant deflationary development, as home affordability will increase and rents will also move down, as people will start buying houses again, moving out of rent. An important factor for the surge in rents in 2021/2022 has been the fact that many people could not afford to buy a house at these prices and chose to rent, increasing the demand for rentals. All this is perhaps about to change.
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Sources of the charts : Factset, if not otherwise mentioned in the chart.