I can’t quite remember how I met Craig Drill, captain of Drill Capital Management, but meet him I did over a decade ago and we have become kindred spirts. Maybe it’s because we both have been in the business a long time, or maybe it is because of our connection to First Boston in a life gone by. Unsurprisingly, Craig is one of the best writers, and investors, on the Street of Dreams. Last Friday he scribed a missive I thought was particularly prescient. The first few paragraphs read like this:
Despite some recent deceleration, a broad-based global economic expansion rolls on. The International Monetary Fund projects real GDP global growth of 3.9% in both 2018 and 2019. The US is enjoying its second longest economic expansion, and as of July 2019, it will gain the distinction of being the longest. In the aftermath of the 2008 Great Credit Crisis, the strength of this expansion, however, is below average. The output gap has closed. Unemployment is down to a spectacular 3.8%, the lowest since 2000. Inflation is brewing, however. The Federal Open Market Committee (FOMC) indicates it is comfortable with a modest interim overshoot of its 2% long-term target as that would reinforce the “symmetric” nature of the target. There is also hope that productivity will improve on a cyclical basis.
Oil prices, a volatile component of the Consumer Price Index, have contributed to headline inflation. In particular, WTI crude at $67 per barrel has rallied by one-third from its 2017 average of $51. Holding aside political and geopolitical risks, rapid escalation in wage rates and consumer price inflation which would turn the FOMC hostile is the biggest risks to the bull market. Problematic wage rate increases (4%) and troubling core consumer inflation (2.5%) is a concern but is a long way off.
We agree, but would note that inflation is building in the pipeline and tariffs are always, and in every way, inflationary. Indeed, the inflation genie is coming out of the bottle and is best reflected in what is occurring in the trucking industry where pricing is up some 27% YTD. As written in our missive of May 21, 2018:
In yesterday's Almost Daily Grant's, Jim Grant talked about rising trucking costs and took some quotes from the biweekly Morgan Stanley Truckload Index: "Flatbed capacity is exceedingly tight and will likely tighten further as milder weather finally arrives in northern regions. There seems to be very large imbalances regionally; creating 'panic' freight buying" according to one anonymous shipper. The CFO with Melton Truck Lines said "We have not seen a rate environment like this for a long, long time, if ever." The CEO of Brenny Transportation said "I've never seen anything like this in more than 30 years in business. Volume was at least manageable a year ago. We were doing well and rates were good. But now it's out of control and we can't keep up." She went on to say that last year shippers waited 3 days to get a truck and now are waiting 10-14 days.
Here is the rub, almost NOBODY is positioned for a return of inflation except for us; and while inflation may be as Craig notes “a long way off” it is surely coming. Verily, you can find nowhere in the world where this much money has been poured into an economy and not had inflation come out the other end. We don’t think it is any different this time. And to reductio ad absurdum the idea of disinflation/deflation, well, you get the idea.
So in my “hit” on Fox last Friday my friend Neil Cavuto interrupted me when I said it is not a trade war, but merely a trade skirmish. He said, “When Mexico puts tariffs on some steel and pipe products, lamps, berries, grapes, apples, cold cuts, pork chops and various cheese products, it sure sounds like a trade war to me.” We will concede that if the counter-tariffs mount, it could turn into a trade war, but at this point we continue to think it is just a trade skirmish. Recall that the Smoot Hawley trade war of the 1930s raised tariffs on over 20,000 imported goods. Also know that across the globe there are already over 100,000 tariffs in place. In our opinion this tariff-tiff is not a big deal, at least as of yet.