Why I think inflation is heading in the right direction

Roger Montgomery

Montgomery Investment Management

With stocks on the rocks, everyone I bump into understandably wants to know if it’s a good time to buy equities – the lure of buying at the bottom is just too great for many to resist. Of course, I don’t have a crystal ball, but there are signs that inflation is heading in the right direction. And, if central banks stop hiking rates, then I think conditions could be ripe for the market to rebound.

Personally, I don’t think a sustained bull market can begin until we see three conditions occurring: 

  1. an end to central bank rate hikes; 
  2. disinflation; and 
  3. positive economic growth. 

All other economic data and indicators point to the direction of one of the above three factors.

One subset of observations relates to global supply chains and whether bottlenecks are easing. COVID-19 inspired enormous global supply chain disruptions, which met surging consumer demand head-on, triggering global inflation rates unseen in decades.

Easing of constraints in the supply chain will help reduce prices for goods, either directly, or indirectly through logistics costs, which should at least reduce the supply/goods side of the inflation equation.

One industry on the supply chain’s centre stage is the auto industry

For almost two years it has contended with locked down labour, and semiconductor chip and wiring bundle shortages that have left dealerships at the mercy of skeletal factory production schedules and consequent stock scarcity.

According to the Wall Street Journal, auto executives are now reporting vehicle availability is slowly improving as those issues are gradually easing albeit unevenly.

In the U.S. new cars and pickup trucks are making their way into dealerships at increasing numbers thanks to increasing factory output and slowing consumer demand as interest rate rises bite. Despite the latter, General Motors Co. (NASDAQ: GM) reported a 24 per cent increase in third-quarter U.S. sales thanks to an easing in the constraints which caused shutdowns in Asia.

The improvements to global supply chains are also benefitting car supply in Australia. According to the Australian Bureau of Statistics, Australia imported a record $2.9 billion worth of passenger vehicles in August. I am glad I sold my five-year-old car back in March because second hand prices will begin to ease now that new car supply is being restored.

And another indication inflation might ease is the value of Australian inbound tourism

In August inbound tourism and overseas students (tourism exports) were flat at half the levels seen pre-COVID. However, according to some analysts, visa application and grants data as well as bookings for student accommodation, suggest a rapid rebound is about to commence.

This latter observation will help to reduce pressure on wages in industries including construction, hospitality and retail. Provided competition remains robust, which it should if slowing economic growth and consumption reduces demand, lower input costs will translate to falling prices and a reduction in the rate of inflation.

That’s a couple of date points suggesting inflation is heading in the right direction. Now we need central banks to complete their job and for the economy to continue to grow. Then conditions for a rebound in equities is in place.

1 stock mentioned

Roger Montgomery
Founder and Chairman
Montgomery Investment Management

Roger Montgomery founded Montgomery Investment Management, www.montinvest.com in 2010. Roger has than three decades of experience in investing, financial markets and analysis. Roger also authored the best-selling investment book, Value.able.

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