Fire Capital Market Outlook - 1Q 2022

For many of us, last year felt much like a continuation of 2020. From some less desirable aspects, perhaps it was. But that continuance also allowed for exciting developments, born from the reality of the pandemic, to gain a stronger foothold now and for our future. As we head into 2022, we want to shed light on several areas of opportunity as well as challenges that will likely shape the coming year and beyond. Here are five themes we are watching closely.

Inflation - May be transitory but the housing shortage isn't

The damaging effects of excess inflation continue to impact wide swaths of the economy. Prolonged supply chain imbalances contributed to high Consumer Price Index (CPI) figures, the likes of which have not been seen in nearly forty years. Recent inflation even exceeds the strong wage growth workers have experienced since returning from pandemic dislocation. While recent signs of replenished inventories provide hope that some supply chain relief is on hand, broad elevated prices are projected to remain well into 2022. Having originally labeled the current bout of rising prices as transitory in nature, the Federal Reserve (Fed) has since acknowledged that the magnitude and persistence of price increases is beyond their initial estimation and policy goal. Accordingly, increasingly more restrictive policy actions have been implemented and interest rates are expected to slightly rise in 2022 in efforts to ease pricing pressure.

In our view, a key component to the synopsis of rising costs felt by consumers is the housing market. This market reflects robust demand outpacing near-term supply in many areas of the U.S.  For more than a decade, household formation has chronically exceeded new home supply. Given the relatively long lead time in construction, we expect this disparity to continue for some time. Additionally, while housing costs should account for roughly 30% of one’s income, high demand locals have experienced rent growth exceeding 20% year-over-year. The impact of such excessive growth has been disproportionately felt by many.

Fortunately, investments in this area have served as an effective inflation hedge thus far, though some moderation is expected.  Ultimately, the value of real estate is negatively correlated with the prevailing interest rate at which it is financed. With expectations that rates will begin to rise, real estate valuation will likely begin to moderate in turn. Importantly, the real estate market will likely be constructive for the foreseeable future due in part to support from fundamental economic elements, such as wage growth and improving employment.

Employment - Structurally different going forward

The job market closed out the year strongly with advances in the employment and participation rate(s) toward the Fed’s full-employment policy goal. A historically large number of job openings continues to reflect the optimistic perspective of employers for future economic growth. However, Americans are taking advantage of their increased mobility and a hot job market by leaving their positions in record numbers. The so-called, “Quits” level surged to a record 4.53 million for the month of November 2021. This phenomenon, commonly referred to as the “Great Resignation,” is widespread throughout the labor force but with diverging outcomes. In fact, more individuals are resigning from the workforce entirely. Early retirement has increased throughout the pandemic as age demographic 55-64 are opportunistically cashing in on the nest eggs afforded by recent record high Housing and Stock Market levels.

On the other end of the spectrum, pandemic displacement has mostly impacted lower wage segments – namely Retail and Hospitality. While multiple factors are likely contributing to the unprecedented amount of employment turnover in these segments, employers are increasingly resorting to automation to bring predictability to their businesses. Unfortunately, this likely means some jobs lost during the pandemic are unlikely to return. For instance, fast food retailers, such as Checkers and McDonalds, have increased the use of Artificial Intelligence (AI) aided menu boards to meet consumer demand in the face of prolonged labor shortages and rising costs. On the bright side, we have observed that corporate capital investment (CAPEX) into such efforts often leads to long term economic growth while also allowing the workforce to develop new skills provided through innovation.

Innovation - Key to all matter of productivity

The propensity to innovate is not just affecting industries with tight labor conditions. The 2020 Honeywell Intelligrated Automation Investment Study reveals that more than half of U.S. companies are “planning to increase automation investments due to Covid-19.” Indeed, necessity is the mother of invention and is an intrinsic element to the strong economic growth we are experiencing. As a natural byproduct of the innovation cycle born from the pandemic, levels of labor productivity are rising. Keenly, productivity growth is seen as a necessary condition for high levels of sustained economic growth and reducing inflation.

Historically, robotic additions tend to be very cyclical, and this cycle has been no exception. Generally, CAPEX investment fall during recessions and then bounce up significantly during expansions. The interplay of machines and human counterparts is symbiotic. The combination supports productivity and profitability -- paving the way for more hiring and making the U.S. more competitive on a global scale. Research recently conducted by the Stanford Institute for Human-Centered Artificial Intelligence found that robot-adopting industries change the work that humans perform but the jobs ultimately do not disappear in the long run. A predominant reason for this may be that companies are increasingly using robots to augment human workers. Car companies, for example, are experimenting with collaborative robots, or “co-bots,” which take on physically demanding tasks while humans focus on detail work, such as customization. While certain human tasks may be displaced in the short run, what will ultimately matter is whether there will be entirely new, more productive occupations, what economists call the ‘reinstatement effect.”

U.S. Onshoring - Time to bring back manufacturing

A long time in the making, the trend for global firms to locate jobs in the U.S. has once again accelerated. In the mid-2000s, China reached a point of competitiveness for labor that forced businesses throughout the world to evaluate where to position production facilities. Exacerbated by the complications caused by the pandemic shutdowns, coupled with the strong V-shaped recovery experienced in the U.S., trade has begun shifting away from China. Supply chain woes aptly demonstrated that many businesses are way too dependent on China. While the move for more control of critical components may have started as a cyclical reversal it has the makings to be a secular improvement in the trade balance for the U.S. going forward.

Attracted by the signs of productivity growth, hundreds of companies announced U.S. onshoring in 2020, with production largely coming from China. The movement appears to be a broad trend, with industries spanning transportation, industrial, and medical equipment. There are other factors at play as well. The Biden Administration has laid out plans to boost U.S. manufacturing by favoring federal government expenditures towards American Made products. Additionally, the global minimum tax rate has placed all OECD countries on an even playing field – tilting the deck towards the U.S. and away from other would-be tax havens.  Taken together, the U.S. is on a trajectory for a robust, diverse, and innovative manufacturing renaissance.

Digital Economy - It's coming for us; ready or not

The digital economy is rapidly expanding and may soon completely transform the way we live our daily lives. In 2019, the digital economy was 9.6% of overall U.S. economic activity and is expected to increase further once 2020 GDP data is announced. The crux of the digital economy is hyperconnectivity with interconnectedness of people, organizations, and machines.  Many of us have already experienced this while working from home but it doesn’t end there. The digital economy is taking shape and disrupting conventional notions about how businesses are structured; how firms interact; and how consumers obtain services, information, and goods.

The internet and cloud developed over the last twenty years has made way for more immersive forms of interaction. In much of the same way, even video meeting platforms, such as Zoom, are encountering new entrants that utilize Augmented/Virtual/Mixed Reality (AR, VR, and MR) to enhance human interaction in the digital realm.   The new frontier is “Web 3.0” and it's being developed in a decentralized manner to transcend the current dimensions of the simple web browsing we are accustomed to. Critical to reaching the full potential of enhancing all aspects of our lives is the deployment and widespread adoption of the digital infrastructure, such as 5G, and higher fidelity communication technology, such as Ultra-Wideband (UWB), which are still likely a few years away. Still, there is little doubt that the share of the digital economy will keep growing, as companies re-invent themselves to keep pace with consumer demands to stay connected.

Disclaimer

The information in this report was prepared by Fire Capital Management. Any views, ideas or forecasts expressed in this report are solely the opinion of Fire Capital Management, unless specifically stated otherwise. The information, data, and statements of fact as of the date of this report are for general purposes only and are believed to be accurate from reliable sources, but no representation or guarantee is made as to their completeness or accuracy. Market conditions can change very quickly. Fire Capital Management reserves the right to alter opinions and/or forecasts as of the date of this report without notice.

All investments involve risk and possible loss of principal. There is no assurance that any intended results and/or hypothetical projections will be achieved or that any forecasts expressed will be realized. The information in this report does guarantee future performance of any security, product, or market. Fire Capital Management does not accept any liability for any loss arising from the use of information or opinions stated in this report.

The information in this report may not to be suitable or useful to all investors. Every individual has unique circumstances, risk tolerance, financial goals, investment objectives, and investment constraints. This report and its contents should not be used as the sole basis for any investment decision.Fire Capital Management is a boutique investment management company and operates as a Registered Investment Advisor (RIA). Additional information about the firm and its processes can be found in the company ADV or on the company website (firecapitalmanagement.com).

CFA® and Chartered Financial Analyst® are trademarks owned by CFA institute.

Jim Ulseth, CFA, CAIA

Jim Ulseth has been working in the ultra-high net worth advisory space for over a decade.