Stagflation Scare? More Bark Than Bite

SUMMARY

• Concerns around a 1970s-style ‘stagflation’ have been rising, in our view.
• We believe these concerns are currently overstated.
• Today, inflation and unemployment are much lower, and growth more stable than in the 70s.

The threat of ‘stagflation,’ much like leisure suits, roller skates and disco, is a 1970s phenomenon that is unfortunately back from the dead. Judging by a recent spike in media mentions of ‘stagflation,’ this issue is now back near the forefront of investors’ concerns. However, despite uneven trends in inflation in 2024, we continue to view stagflation as a low probability outcome. In our 2024 Outlook published back in December, we placed only a 25% probability of a ‘Stagflationary Scare’ over the next 12 months that would pressure both equity and bond markets…today we would place those odds at even lower levels.

True stagflation is a challenging economic environment where inflation and unemployment are elevated and persistent. This forces the Federal Reserve to keep rates high and restrict money supply even as the economy slows, and unemployment ultimately accelerates. This dynamic creates a vicious cycle of low economic growth combined with high unemployment and prices.

The 2020’s are NOT the 1970’s…. Inflation and Unemployment Lower Today

‘Stagflation’ was coined in the 1970’s, when runaway inflation driven by an oil embargo ultimately caused the Federal Reserve to engage in not one but multiple rate hike cycles. This culminated in extremely high interest rates that finally brought lasting inflation relief by the early 1980s, but at a high economic cost. This painful period — defined by the St. Louis Fed as 1967-82 — was epitomized by abnormally high and sustained readings on the ‘Misery Index’, an economic measure that simply adds consumer inflation to the unemployment level (see shaded region, Chart 1, below).

Real Economic Growth More Stable and Sustainable Now

It’s comforting to see just how much better the economic backdrop is today compared to the 1970s, but what about the potential for stagflation to settle in over the next couple of years? Admittedly, RiverFront expects a ‘reflationary’ environment through the next business cycle, wherein inflation may have a challenging time moderating all the way back down to the Fed’s 2% target in the near-term. This is partially a function of the inflationary impacts of heightened geopolitics, encouraging ‘friendshoring’ and other supply chain realignments in light of wars (both cold and hot) in Asia and Europe.

However, the positive side to our ‘reflation’ view is the solid ‘real’ (inflation-adjusted) economic growth that accompanies it. This, in our view, is underpinned by the US’s superior productivity relative to other large economic blocs, a highly positive disinflationary impulse which we have discussed at length (see Weekly View on American Economic Exceptionalism). We view the rapid adoption of artificial intelligence as another potential significant productivity enhancer through the next business cycle, with much of the economic benefit accruing to US companies. This US ‘economic exceptionalism’ is in full display, in our view. The Atlanta Fed GDPNow Tracker, a real time forecast of economic growth, is currently annualizing at around +3% year-over-year GDP growth for Q2, a solid reading, in our opinion.

CONCLUSION

In conclusion, while the risk of stagflation has not gone away, the likelihood of it happening has diminished since the beginning of the year, in our view. This is one of the reasons we remain constructive on US equity markets and why our balanced portfolios continue to slightly favor stocks over bonds.

^{1 https://www.stlouisfed.org/open-vault/2022/nov/three-ways-high-inflation-ends}

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