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Why inflation might prove to be more ‘durable’ than transitory

Ellen Hazen, Portfolio Manager at F.L.Putnam, joins Yahoo Finance to discuss the latest economic data and inflation concerns.

Video Transcript

- But I want to continue this conversation now with Ellen Hazen, Portfolio Manager at Putnam. Let's keep this market conversation going.

So Ellen. I want to start with some of these inflation numbers. I was talking to Keith fitz-gerald about this in the last hour. And I'm curious to get your thoughts.

Just because we have repeatedly heard the Fed say that inflation moves right now are transitory. They are absolutely temporary. And yet we continue to get some of these inflation figures that continue to run hot large surges year over year setting some-- some records numbers that we have not seen in a couple of decades. Of course, the real estate market running hot as well.

So I'm curious to know if you think that some of these inflation trends perhaps are a little bit more durable than some of the-- the commentary about it being transitory

ELLEN HAZEN: Thanks, Christine. We are concerned that inflation will prove to be more durable than transitory. And I think that one of the reasons is that the numbers the Fed looks at are somewhat lagging indicators. Chair Powell made a real point of saying that it's things like rental cars, new cars, airfare, hotels, things that are-- are temporary in nature.

But I've been scrubbing earnings calls over the last two weeks for the second quarter. The first thing I would say is that if you look just at management prepared commentary, so not even looking at the Q&A, but just what they put in their prepared remarks.

Of the 300 S&P companies that have reported so far, there have been 600 mentions in the prepared commentary of inflation. And that compares to only 200 mentions in the first quarter. So more than triple the number that we saw in the first quarter.

And then of course, if you add in the Q&A, you see a lot more mentions. Moreover, if you listen to the companies, and I looked at companies across consumer discretionary, across industrials, across materials, a lot of different companies. They're seeing it everywhere.

They're seeing it in wages. They're seeing it in logistics. They're seeing it in freight.

They're seeing it in fuel. They're seeing it in electric, and electronic components. They're seeing it in input costs commodities like steel or agricultural commodities.

And they're generally guiding for continued pressure into the third quarter. And so based on what the companies are saying, it does not appear that it's going to be all that transitory. And to be clear, Chair Powell did say that he thought that the prices will go down again. It just means that we may not enter into an inflation spiral. That may be the case.

But companies are either going to have to pass this along to consumers or they're going to have to have crimped margins as we go forward. And neither of those is going to be good for stock prices as we look toward the next couple of quarters.

- I'm glad you brought that point up, Ellen. Because I was curious to know how some of these companies do plan to handle inflation going forward. We have seen really sky high prices, particularly if you're trying to go buy a car right now, of course, that's boosted by some of the chip shortages that we have been seeing.

But how are companies as you're hearing it preparing to handle that? Are they planning to pass that on to the consumer or are they planning really to take some of those hits as you mentioned on the margins?

ELLEN HAZEN: This really goes to the heart of how you want to be positioned in the back half of the year. From November until now, the narrative has been all about growth versus cyclicals, cap versus, small cap. But I think the correct dichotomy right now is actually pricing power versus not pricing power. And it really varies by company.

Some of them are able to pass along costs and actually increase margins. For example, some of the food companies have had to deal with commodity cost changes for years. And many of them saw this coming, put hedges in place, and have been increasing price fairly rapidly along with that.

So they're not going to see a whole lot of impact to their margins. Similarly, defense contractors, for example, are mostly on a cost plus basis. And so you really are not going to see the impact too much there at all. On the other hand, companies that are not accustomed to taking price increases on a regular basis a lot of times really got behind the curve.

And so I was listening to a couple of companies this morning that said they've just announced their third price increase in the last 12 months or their fourth price increase in the last 12 months. And it's going to take a while to flow through to their customers. And so because they're behind, their margins might recover, but not in Q3 or Q4, maybe not until next year.

And then, of course, there are some companies that can't pass along the price increases at all. And those ones are going to have to have lower margins.

- I want to ask you now about risks to the market, especially because of the Delta variant. We were chatting with the doctor a little bit earlier on the news. From the CDC that says the Delta variant frankly, is more contagious than chicken pox and it can be spread by vaccinated folks just as easily as those that are not vaccinated.

Now we've seen Delta variant concerns hitting the markets. In the last couple of trading sessions, we have seen some sell offs because of concerns of coronavirus. How much do you think that the variant and the pandemic right will continue to be a headwind really to markets going forward?

ELLEN HAZEN: The first thing about markets is that they're already up 18% year to date. So you don't need much of a headwind, whether from Delta or anything else to cause a hiccup there. But in terms of COVID particularly, I think what we'll find is that vaccinations as they continue to increase, this becomes more and more as they say like the flu or other illness that we're accustomed to having and that we don't shut the economy down over.

And it has been observed that it's a crisis among the unvaccinated rather than the vaccinated. Maybe that will cause some vaccinations to pick up. I have seen some data that says that in counties where the hospitalizations are highest, you are seeing increased vaccination take.

So we may see that increase. But-- but eventually, the public will converge on treating this as something which is manageable either by increasing their own vaccinations or by doing social distancing, masking, staying at home, et cetera. So I think it's unlikely that we're going to see the degree of economic slowdown that we saw last summer and even last winter.

I think the public is coming to terms with this. But with market valuations where they are, there's not a lot of room for error. And so any kind of a hiccup as I said could-- could cause volatility in the equity markets in the third and fourth quarters.

- All right. We're going to have to leave that there. Ellen Hazen, Portfolio Manager at FL Putnam. Thanks so much for joining us today.