Experts tell us that stagflation is defined by stagnant economic growth and elevated inflation. So, people can find it hard to get a raise. They might get laid off. And everything costs more when they go to a store. Stagflation is also bad news for both stocks and bonds. It’s hard for companies to make profits and bond coupons have trouble keeping up with rising inflation.
Some readers will remember the 1970s and those difficult economic conditions. That was the last time the U.S. economy dealt with stagflation. Back then, the U.S. faced rising energy prices as we do now. But in the olden times, we used A LOT more fossil fuels than we do now. By some measures, we use only about half as much fossil fuel per unit of production as we did in the 1970s. So, experts do NOT think that our current energy pinch will create the lasting damage we suffered 50 years ago.
One reason you will hear a lot about stagflation is that policymakers dread it. They have few monetary tools to combat stagflation. Raising interest rates may help reduce inflation, but the increased borrowing costs that result would further depress growth. Alternatively, keeping monetary policies loose, could push prices higher and amplify inflation.
IS STAGFLATION A SIGNIFICANT RISK AT PRESENT?
From the definitional sense, one may argue that we are currently experiencing stagflation as we saw negative GDP growth in the first quarter, while inflation is hovering near its highest levels in 40 years. However, when digging deeper into the data, stagflation may not be something you should be too worried about. Here’s why:
Stagflation is typically accompanied by faltering demand.
In the Q1 GDP reading, personal consumption and business investment grew at a +3.1% and +9.2% annual pace, respectively, according to Bloomberg as of 5/26/2022. As the largest driver of the U.S. economy, an acceleration in consumer spending is good news. We hope that the underlying momentum in the economy remains positive. Similarly, ramped-up business investment shows companies are confident in continued consumer demand, which should lead to economic growth.
Stagflation is also accompanied by rising unemployment.
Employers have added more than 400,000 jobs a month for 12 straight months, and the unemployment rate is near a half-century low. Businesses are advertising so many jobs, that there are now roughly two openings, on average, for every unemployed American.
Stagflation is mainly caused by supply chain disruptions leading to higher prices.
The New York Federal Reserve’s Global Supply Chain Pressure Index (GSCPI) increased for the first time since December 2021, however, this was mostly due to longer delivery times in China and the Euro Area, driven by lockdowns and the Russia-Ukraine conflict. While we acknowledge that heightened geopolitical tensions could continue to stoke supply chain pressures in the near term, most of the components of the GSCPI declined in April, which is a positive sign that pressures stemming from COVID 19-related lockdown measures have mostly abated domestically.
Supply is still constrained, but demand, particularly labor demand, is likely to remain firm. Although investors are now focused on rate rises and higher inflation, the reality is that the consumer is still spending and, therefore, we still expect a continued global economic recovery.
So, I suggest that when you hear of threats of stagflation in your “financial media” it’s important to remember that the media is in the business of selling advertising. They have found the get more people to hang around during commercials when they talk about alarming and scary things. So, you should expect to hear plenty about stagflation.
But, remember consumer balance sheets are strong thanks to the savings accumulated during pandemic lockdowns. At the same time, business profits, while increasing at a slower pace than in 2021, are still growing and have already surpassed pre-pandemic levels.
So, most experts continue to remain hopeful about stocks and particularly the stocks of companies that pay dividends. For investments that pay a coupon, experts still urge caution, because longer-term bonds are VERY sensitive to any movement in interest rates. But, if you own a mix of dividend-paying stocks and shorter-term bonds, you can take comfort that you will get some income as you wait for share prices to recover and markets to stabilize.
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