The first quarter of 2022 was a particularly volatile period for the stock market. Uncertainties about the pandemic led investors to rush into ‘re-opening’ plays one day only to reverse course the next as reports of a new, more virulent strain created fears of another shutdown. Russia’s invasion of Ukraine added a whole new layer of uncertainty as investors tried to fathom the effects of sanctions and disrupted trade. Oil prices surged, as did prices of other commodities, leading to significant shortterm inflationary pressures on top of those stemming from Covid-related supply chain disruptions.
In response to these inflationary pressures, the Fed began its much-anticipated move toward tighter monetary policy and higher interest rates. This in turn created yet another layer of uncertainty for equity investors, as higher interest rates ultimately lead to lower equity valuations.
Underneath the short- or immediate-term concerns, we believe there is a longer term, potentially much more persistent issue, namely a reversal of the benign effects of globalization. As our clients know, we have written for years about the combined effect of globalization and technology in taming inflation and bringing it down below 2%. Globalization – especially the opening of China and Eastern Europe – afforded the world a vast supply of cheap labor and enabled companies to move manufacturing offshore to produce goods more cheaply. Labor unions were also weakened as a direct consequence of cheap labor from globalization, leading to a multi-decade collapse in unionization in the U.S. from 20% in 1983 to 10% in 2021.
In addition, technology in all its myriad forms enabled businesses to streamline processes and become more efficient (i.e., operate at lower cost), while also affording consumers unprecedented price-discovery power. This too kept the lid on inflation. While globalization destroyed labor’s ability to demand higher wages, technology destroyed some businesses’ power to raise prices at will and structurally lowered input costs.
We contend that globalization is now in retreat, and that after three decades of falling inflation we are entering a multi-decade period of rising inflation. We do not expect annual inflation growth to remain at 6.4% – its latest reading excluding food and energy – but to settle in at a rate above 2% and probably trend higher from there. The temporary pressures from Covid-related supply chain disruptions and the Ukraine invasion/Russian sanctions will eventually abate. But the reversal of globalization will have a persistent impact on labor costs and long-run inflation.