A fully loaded HMM container ship waiting to dock at the Port of Oakland in California.
Michael Vi/Alamy
If given the opportunity, most people would use a time machine to right a wrong or see the future. But Wall Street seems to want to go back to the 1970s, when stagflation reigned.
At one point, stagflation—a combination of economic stagnation and inflation—was considered almost mythical. How could growth stagnate while prices continued rising? Then the 1970s hit. Richard Nixon caused the dollar to tumble by taking the U.S. off the gold standard, oil prices soared thanks to an embargo, and companies responded by charging more and making less. It was only through a painful series of interest-rate hikes and recessions that the U.S. finally shook it off.
Now the specter of stagflation has returned. It’s not just the number of reports hitting my in-box that suggest this. J.P. Morgan released a survey on Oct. 13 showing that 42% of respondents believe that the U.S. is careening toward a stagflationary future. Even Google Trends shows that searches for the term have started climbing again.
“The term ‘stagflation,’ which was widely used in the 1970s and the early 1980s, essentially disappeared from the lexicon over the subsequent few decades,” writes Jay Bryson, chief economist at Wells Fargo Securities. “However, it has become in vogue again recently with the marked rise in inflation that is due, at least in part, to supply constraints.”
It’s easy to see why, at least from the inflation side of things. The consumer-price index rose 5.4% in September from the year-earlier level, putting it on track to grow at its fastest pace since at least 1990. Input costs have been worse, due to shortages and delays, helping to push the producer-price index up 8.6% in September, year over year.
The stagnation fears are more difficult to understand. Yes, third-quarter gross domestic product is almost certainly going to disappoint, as the consensus expects it to grow by 3.6%, while the Atlanta Fed GDPNow forecaster puts it at just 1.2%. Much of the decline, however, is due to Covid’s Delta variant and those nasty supply-chain problems, which should ultimately fade. “Elevated inflation and slowing growth ‘feels’ stagflationary,” writes Joseph Kalish, chief global macro strategist at Ned Davis Research. “Growth is too strong to be considered stagflationary.”
There are even signs that some of the forces pushing inflation higher—and growth lower—are starting to dissipate. Shipping deadlines for the holiday season arrive near the end of the month, and that should allow goods that don’t have a seasonal deadline to start making their way at a more leisurely pace. Also, President Joe Biden has a plan that could reduce the bottlenecks, with ports operating 24/7, something that seems unfathomable for them not to be doing already. “By the first quarter, supply-chain bottlenecks should begin to ease as seasonal demand declines sharply, allowing inventories to be rebuilt,” writes Jefferies economist Aneta Markowska.
The financial markets seem to agree. Copper, an industrial bellwether, surged 11% this past week, its largest one-week gain since 2011. Gold, usually a haven in uncertain times, advanced just 0.6%. That sent the so-called copper/gold ratio to its highest level since 2013, which signals strength in global industrial demand and indicates that U.S. monetary policy isn’t too tight and won’t derail the economy.
“If the Fed tightens too much or global growth slows due to outside shocks, this would tend to be a headwind for metals, but we do not expect the Fed to be back in front of the neutral rate/velocity curve for some time,” explains Michael Darda, chief economist at MKM Partners. “The market behavior this year tells us that a further or sustained rise in risk-free rates will likely catalyze an ongoing rotation in equity sectors in which value-oriented and reopening plays outperform growth-based, high-valuation stocks and sectors.”
Stagflation would be a painful experience for stocks.
Goldman Sachs strategist David Kostin notes that since 1960, there have been 41 quarters of high inflation and weak economic growth. During those quarters, the S&P 500 index averaged a -2.1% real total return, well below the 2.5% average gain for all quarters. Kostin recommends a basket of stocks with high pricing power—companies such as 3M (ticker: MMM) in industrials, Vulcan Materials (VMC) in materials, and Procter & Gamble (PG) in consumer staples—for investors worried about stagflation, though he doesn’t expect it to materialize. “Third-quarter EPS reports will highlight input cost pressures, but peaking inflation in coming months should reassure investors and help lift the S&P 500 to 4700 by year end,” he writes.
And that’s the problem with betting on stagflation—to happen, it needs a rare combination of events. Even just betting on inflation staying as high as it is now seems like a losing wager, observes Nicholas Colas, co-founder of DataTrek Research. Over the past four decades or so, he points out, the U.S. has had difficulty sustaining even 4% annualized inflation for very long. In the 1980s and 1990s, the average was about 3.5%, and in the past 20 years, it has been just 2%.
“To believe the American economy has suddenly entered a new inflation regime, one must shut the door on 40 years of economic history and venture off into the unknown,” Colas explains. “It will take a lot, and by that we mean several quarters, if not a few years, of hot inflation data to alter market perceptions.”
In other words, we still have time.
Read more Up and Down Wall Street: Big Tech Rules the Stock Market. Why It’s Not Time to Relax.
Write to Ben Levisohn at Ben.Levisohn@barrons.com