This Too Shall Pass: The Micro Case for Transitory Inflation
US inflation continued to soar in May, with the Core Consumer Price Index (CPI) up 0.7% month over month and 3.8% year over year—its highest annual rate in more than 25 years. That worries investors, and understandably so. Even moderately higher inflation erodes the real value of investment returns and often leads to higher interest rates. But is higher inflation here to stay? We don’t think so.
We believe this jump in inflation is temporary. We expect price increases to decelerate as the year progresses and as pandemic-induced supply constraints ease, allowing supply to catch up to demand and taking the pressure off prices. That’s the case for transitory inflation as we’ve argued it from the macroeconomic perspective.
But to test our hypothesis, we drilled deep into the underlying data—company by company—to understand the microeconomic case. Would businesses tell us a different story?
Natural Language Processing: Harnessing the Power of Big Data
Building a micro case for inflation is akin to examining each grain of sand on a beach, then rolling up the data to create a picture of the shoreline. Processing such an enormous data set requires a big-data solution. In our case, we turned to natural language processing (NLP), which allows computers to make sense of the content of written documents.
We began with an NLP analysis of nearly 30,000 earnings-call transcripts for 3,200 publicly traded US companies. We flagged all management discussions of inflation, as well as drivers of inflation and how management teams were adapting. In addition, we analyzed the words and phrases surrounding inflation mentions for insights into likely margin effects. Here’s what we found.
First, mentions of inflation tripled in February 2021 compared with both January 2021 and February 2020 as cost pressures began to occupy a larger share of management attention. The industrial and consumer sectors stand out for having the most mentions of inflation. That’s not surprising, given the bigger impact of the shutdown on goods and services.
Second, for now, companies appear to be absorbing much of the run-up in costs, rather than passing costs through to buyers. We see this in the context around inflation mentions, which, in aggregate, leans toward a margin-neutral or margin-negative tone. In contrast, a margin-positive tone would suggest that cost inflation can be passed through to consumers as price inflation.
Third, management teams attribute a significant amount of inflation to disruptions in the labor markets and the supply chain (Display). In our view, these kinds of pressures will be temporary, as vaccinations progress, schools reopen and enhanced unemployment benefits expire in the next few months, leading workers to rejoin the labor force.