July 7, 2021 – Is It Transitory?

Happy summer! We hope that this letter finds you well. As is the case across the financial markets landscape,
our focus is currently on inflation. The Federal Reserve recently increased their expectations for inflation in the
short to medium term, but they still insist that this period of rising prices will not persist. The question that
financial markets have been forced to grapple with lately has been, “Is it transitory?”

The Citi US Inflation Surprise Index is a measure by which economists illustrate the degree to which actual data
is either beating or missing expectations. As can be seen in the chart on the bottom left, over the past six months
this index has spiked to unprecedented levels. The US Personal Consumption Expenditures (PCE) reflects
changes in the prices of goods and services purchased by US consumers and is now well above the average pace
of the past decade, but is this just a short-term blip? How long will this period of higher-than-expected or higher-
than-average inflation last? Are we at the beginning of a lasting period of rising producer and consumer prices,
rising wage pressures and rising long term interest rates, or, as the Federal Reserve believes, is the recent surge
a result of a transitory disruption to global supply chains and a short-term boost to demand as economies around
the globe continue to reopen following one of the largest economic disruptions of the past century?

A recent report from the White House Council of Economic Advisors attempted to address this question by
comparing today’s situation to previous periods of inflation. They began:

Supply chain disruptions are having substantial impact on current economic conditions. Economy-wide
and retail-sector inventory-to-sales ratios have hit record lows; homebuilders are reporting shortages of

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 key materials; and automakers do not have
enough semiconductors. Elevated consumer
demand is adding fuel to the fire. Travel
demand, for example, has returned much
more sharply than expected, which is
straining airline operations. Similarly, total
vehicle sales in April more than doubled from
a year prior, which is leading to empty dealer
lots. The combination of a spike in consumer
demand and a supply chain that is not fully
operational has contributed to rising prices.
- White House Council of Economic
Advisors, July 6, 2021

The first half of this year saw the largest gain in

commodity prices in almost fifty years. As
mentioned above, the supply disruptions caused
by Covid-shuttered manufacturing and
processing plants and the closure of ports coupled
with the increased demand from an awakening
global economy flush with cash from
unprecedented fiscal stimulus has combined to
drive the prices of everything from food and
lumber to energy and industrial metals soaring.

West Texas Intermediate, the US oil-price

benchmark, hit $76.98 a barrel on Tuesday
(July 6th), its highest level in six years, as
OPEC, Russia and their allies again failed to
agree on production increases… Reflecting
the increase in crude prices, the average price
of a gallon of regular gasoline in the United
States has risen to $3.13, according to AAA, up
from $3.05 a month ago. A year ago, as the
coronavirus kept people at home, gas cost just
$2.18 a gallon on average. The auto club said
on Tuesday that it expected prices to increase
another 10 to 20 cents through the end of
August.
-New York Times, July 6, 2021

At some point the supply constraints associated

with Covid restrictions should abate, but what of
the demand side of the equation? The
International Monetary Fund recently reported
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 they expect that a hot US economy could keep
demand for goods and services elevated but that
runaway inflation should not be an issue:

The International Monetary Fund raised its

2021 US growth projection sharply to 7.0% due
to a strong recovery from the COVID-19
pandemic and an assumption that much of
President Joe Biden’s infrastructure and social
spending plans will be enacted.
The IMF’s latest forecast, marking the fastest
US growth pace since 1984, compares with an
April projection of 4.6% growth in 2021. The
Fund raised its 2022 US GDP growth forecast
to 4.9%, up from its previous 3.5% April
forecast…
“Indicators suggest significant labor market
slack remains which should serve as a safety
valve to dampen underlying wage and price
pressures,” the IMF said in its review
statement.
The Fund added that it expects US inflation
expectations to remain well-anchored, but
these “will be obscured in the coming months
by significant transitory movements in
relative prices,” which could cause personal
consumption expenditure inflation to peak
temporarily near to 4% later this year.
- Reuters.com, July 1, 2021

The latest unemployment rate of 5.9% suggests that there are millions of Americans that are still in need of jobs
following this last year’s disruptions. However, many employers in the retail and hospitality industries are
finding it harder and harder to lure new hires in to fill vacant positions. Wages in the lowest paid sectors of
the economy are up sharply over the past quarter and, while those wage gains may be long overdue, at some
point businesses will pass those additional costs on to consumers.

[The most recent report from the Labor Department] suggests that American workers are enjoying
an upper hand in the job market as companies, desperate to staff up in a surging economy, dangle
higher wages. In June, average hourly pay rose a solid 3.6% compared with a year ago – faster than
the pre-pandemic annual pace. In addition, a rising proportion of newly hired workers are gaining
full-time work, as the number of part-time workers who would prefer full-time jobs tumbled – a
healthy sign.
- TechWire, July 2, 2021

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 Many have argued that once the increased federal
unemployment benefits roll off we will see a surge
of eager applicants. However, data released by job
posting site Indeed.com has shown a smaller than
expected share of job searches in those states that
ended the supplemental benefit in June and only a
slightly larger share in states that plan to end the
benefit in July. It appears that low-wage workers
have gotten the memo that they can hold out for
better pay, better benefits or both.

Wages, once raised, tend to be sticky. If you hire

an employee at $20/hour, it is very unlikely that
employee will accept a cut in pay because gasoline
or food prices have reverted due to an easing of
supply constraints. The same is true of housing
costs.

We have seen a dramatic increase in home prices

across the country this year, as near-record low
mortgage rates, near-record low inventory and
increased mobility due to remote work has turned
virtually every home listing into a bidding war.
Rents, however, have not kept pace with
ballooning home prices. The last time the Price-to-
Rent ratio was this high was at the peak of the mid-
2000’s housing bubble, which as we painfully
remember was followed by a dramatic drop in the
price of homes. This time around it is possible that
the ratio will revert due to an increase in rents,
which in many areas have been stagnant not due to
demand but due to federally imposed eviction
moratoria.

When it comes to housing, the economic

recovery has diverged along two tracks. On
one side is a housing boom. Home prices are
soaring, with buyers clamoring in extremely
competitive bidding wars that often hinge on
all-cash offers. The cost of building materials,
worker shortages and a lack of available houses
are pushing prices up even higher. In April, annual home-price gains were at 14.6 percent, according
to the S&P CoreLogic Case-Shiller National Home Price Index.

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 Yet on the opposite end of the recovery, many renters are still reeling from the coronavirus recession
and remain behind on bills. Landlords are strapped for income… Some economists wonder whether
rising home prices will, in time, translate to higher rent prices…
- Washington Post, June 30, 2021

The final eviction moratorium put in place last year by the CDC will expire at the end of this month and those
landlords whose renters who were unable or unwilling to make rent payments over the past 16 months will
have an opportunity to seek new tenants at higher rents. Their ability to fill those rental units and the new
equilibrium prices they are able to charge will be very telling. The federal government is very good at creating
emergency measures that tend to stick around long after the emergency has faded. The shifting balance of power
from landlords to tenants may further contribute to rising rents, as real estate investors seek to be compensated
for the additional risk of future interventions.

Increased wages on the lower end of the income spectrum will help cushion some of the blow of increased rents
but increases in wages and housing costs are two crucial ingredients to persistently higher levels of inflation. As
the supplemental unemployment insurance payments have been rolling off across the country, and the rental
market adjusts to the new post-moratoria environment, we will get a much clearer view of how the financial
market participants’ inflation expectations are likely to evolve.

The chart on the left breaks down the historic

performance of global equities during periods of
rising or falling real interest rates and inflation
expectations. The most beneficial environment
for stocks over the past two decades has occurred
when inflation expectations are rising, which is
intuitive because rising inflation expectations
indicate expectations for a growing economy. The
goldilocks scenario, especially in recent years, has
been rising inflation expectations and falling real
rates, which occurs when the expected pace of
economic expansion outpaces the rise in interest
rates.

Our position is that the uptick in inflation

expectations is going to be with us for some time,
but that global central banks will keep interest
rates low to help limit the cost of servicing the
massive amount of federal, state and private debt
added during the pandemic.

The ongoing disruptions to the global supply

chain are unlikely to fully abate in the short term,
and the longer they last the likelier they are to
become imbedded in both producer and
consumer behaviors and expectations, and
increased wages and continued fiscal support,
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such as the forthcoming monthly Child Tax Credit payment, are likely to keep demand for goods and services
elevated.

The Biden Administration’s massive push to update and improve infrastructure and a concerted international
effort to “green” the global economy will also add to the demand for raw materials, labor and industrial
equipment.

All of this leads us to target our equity exposure in areas that have fared well in inflationary environments in
the past and that are more favorably valued than the broader equity market. While share prices may be
somewhat volatile over the next few months as markets digest each updated data point, shares of companies
that produce, refine or process raw materials should serve us well. From renowned asset management firm
Grantham Mayo Van Otterloo (GMO):

Historically, resource equities have not only

protected against inflation, but have actually
dramatically increased purchasing power
during inflationary periods. In the US, we’ve
identified eight periods of time where inflation,
as measured by CPI, was more than 5% per year
for a period of one year or longer (top left chart).

In those inflationary periods, a basket of energy

and metals companies kept up with or beat
inflation six out of eight times, and in all eight
periods the commodity producers
outperformed the S&P 500*. In fact, the
commodity producers delivered real returns of
more than 6% per year on average during these
inflationary periods as compared to a
destruction of purchasing power of around 1.6%
per year for the S&P 500.

Whether this year’s price rises are merely

transitory or something longer lasting, the
opportunity in energy and metals looks very
appealing from a historical perspective. Energy
and metals companies are trading at a discount
of over 70% to the S&P 500 Index, the biggest
discount we have ever seen with the exception
of other points in the last year or so (bottom left
chart). In fact, energy companies are trading at
the cheapest levels in absolute terms that we had
ever seen prior to Covid.

- GMO Focused Equities Team, June

2021

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There is likely to be a good bit of volatility in the “inflation trade” over the remaining summer months as the
more thinly traded financial markets digest the reopening economy, consumers’ ability to stomach higher prices
and the Federal Reserve’s likely response. We have seen in just the past several weeks a pullback in resource
equities as the spread of the Covid-19 Delta variant has raised questions about the pace of growth amid the
potential for reimposed social restrictions. Longer term, however, we remain confident that our exposure to
energy, metals and miners, as well as our continued focus on precious metals and infrastructure-related
investments, will serve us well.

The ongoing question that will be asked by market participants for

the foreseeable future regarding inflation will be “Is it transitory?”
Our expectation is that the answer is “No” and that we have entered
a period of persistently higher than average, though not runaway,
inflation. This will not be the 1970’s all over again, but with low
interest rates, a hot economy and a federal government eager to
spend, an average inflation rate of 3-4% is more likely than 1-2% for
the next several years.

Thank you for taking the time to read this quarter’s letter. We hope that you have a great rest of your summer!

Sincerely,

Clay Ulman, CFP® Jim Ulman, ChFC, CLU, MBA

*The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure
performance of the broad domestic economy through changes in the aggregate market value of the 500 stocks representing
all major industries. The Dow Jones Industrial Average (Dow) is a price-weighted index of 30 significant stocks traded on
the New York Stock Exchange and the Nasdaq. The Nasdaq 100 Index is a basket of the 100 largest, most actively traded
US companies listed on the Nasdaq stock exchange. Indices such as the S&P 500 Index, the Dow Jones Industrial Average
and the Nasdaq 100 Index are unmanaged, and investors are not able to invest directly into any index. Past performance
is no guarantee of future results.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or
recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial
advisor prior to investing. The economic forecasts set forth in the presentation may not develop as predicted and there can
be no guarantee that strategies promoted will be successful. All investing involves risk, including loss of principal. No
strategy assures success or protects against loss.

All indices are unmanaged and cannot be invested into directly.

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