Inflation is in ‘structural shift,’ and these markets will benefit

A mining truck takes ore from the pit to a crusher at the MP Materials rare earth mine in Mountain Pass, California, January 30, 2020.

Steve Marcus | Reuters

European stocks are set to outperform the U.S. as inflation sticks around and commodities begin a new “supercycle,” according to Livermore Partners Chief Investment Officer David Neuhauser.

The U.S. consumer price index on Thursday showed a 5% jump in headline inflation in May from the previous year, its sharpest increase since 2008. Core inflation, which excludes volatile food and energy prices, also notched a 28-year high of 3.8%. 

While markets have broadly dismissed the current red-hot inflation figures as transitory and fueled by short-term anomalous factors, Neuhauser argued that a more fundamental “structural shift” was taking place.  

Livermore Partners has noted that wages are not rising as much as would normally be expected alongside GDP growth rates upward of 6%. Real average hourly earnings in the U.S., which account for inflation, were down 2.8% in May from the previous year, according to the Bureau of Labor Statistics.

“As you are seeing prices for automobiles, as prices for houses, as prices for food and energy go up, even though it looks like the economies are starting to boom, the real issue is you’re not seeing wages grow as fast,” Neuhauser told CNBC’s “Squawk Box Europe” on Friday. 

“Thus ultimately that is going to start to pinch the consumer and as you know, the consumer is 70%-plus of the economy.” 

If inflation is indeed here to stay, as Livermore Partners anticipates, Neuhauser suggested this will cause troubles down the line and will cause the Federal Reserve to apply the brakes to its accommodative monetary policy. 

Wage growth sluggish 

Neuhauser pointed to McDonald’s and Chipotle as examples of companies that have begun to incur substantial and rising input costs while struggling to attract workers in the wake of the pandemic, leading them to offer bonuses and focus on wage growth. 

“That is ultimately going to increase the price of their goods and services, which will of course increase the prices to consumers,” he added. 

This could cause problems if these trends combine with the potential tapering of the Fed’s unprecedented bond-buying program, Neuhauser suggested. 

“That is going to have the potential at least to start to rerate markets, which look extremely frothy. Ultimately, that is what you have to focus on as an investor,” he said.  

“You have to look at the numbers and you can push them off to the side, but you can’t do that if you start to see more consistent hotter numbers running forward.” 

Commodities ‘supercycle’ 

Neuhauser’s fund is now largely focused on commodities, banks and industrials, as he believes commodities are in the start of a new “supercycle” — a decades-long period in which commodity prices remain above long-term trends.

“We have seen (fewer) mines being built, we have seen oil and gas see capex (capital expenditure) being pulled away as banks aren’t lending anymore, you are seeing ESG initiatives make front and center stage when it comes to board meetings,” he said.  

“I think there has been this structural shift where you have not seen capital, capital has been starved to the complex and ultimately you have a dollar that is looking to potentially fall apart.”

This shift means commodities are the place to be for investors over the next three to five years, he argued.

“We are playing that in terms of some of the smaller cap free cash flow or cash flow businesses out there,” he said.  

“A lot of it is in Europe and a lot of it is international, so I think Europe is going to outperform the U.S. as we go forward, and that is where most of our capital is actually at Livermore, in a lot of these European stocks tied to mining.”

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