Stagflation?
“Stagflation” is a portmanteau word combining stagnation and inflation. It represents the worst of three worlds, occurring when the rate of inflation is high, economic growth is slow, and unemployment is high.
The threat of stagflation reflects the balancing act that the Fed has been performing this year. How do you lower inflation, largely through interest rate increases, but avoid throwing the economy into a recession and creating higher unemployment? Let’s examine each of the three-legged stool of stagflation.
Inflation
We are in a period of high inflation. Markets reeled when the Consumer Price Index jumped 8.3% in April from a year earlier and rose 8.5% in March. Fed Chair Jerome Powell has a cogent plan to lower inflation and is committed to keep ratcheting up the Fed’s interest rates until inflation is “coming down in a clear and convincing way.” Powell has become more hawkish than he has been for the past two years, but we do not think he is as extreme in fighting inflation as his predecessors Alan Greenspan and Paul Volker. We believe that he is maintaining his high-wire walk with aplomb.
We are not ready to say that inflation has peaked, but we are seeing some encouraging signs that Chairman Powell’s tightening is having some beneficial effects. We may be close to a peak.
- The Composite Purchasing Managers Index for manufacturing and services fell to 53.8 from 56.0 in April. A reading above 50 indicates expansion in the private sector.
- The Michigan Consumer Confidence Index: Expectations: Income rose to 16.5% in April over March’s 15.1%.
- The Producer Price Index fell to 11% in April, down from 11.5% in March.
- The PPI rose 6.9% in April, year-over-year, excluding food and energy.
- April’s PPI was the lowest since September 2021.
- The prices of used cars declined in March and April, dropping 1% in April.
- Supply chain clogs are mitigating.
- Global shipping rates are down 28% from this time last year.
- Sales of new single-family houses fell 16% in April. New home sales have fallen for five consecutive months and by more than 10% in March and April.
- According to Fannie Mae’s Home Purchase Sentiment Index for April, Americans’ attitude toward buying a home has fallen to its lowest level since May 2020. Only 19% of consumers believe it is a good time to buy a home.
- Energy prices fell 2.7% in April, from an 11% rise in March.
- Increased wages are being offset by greater employee productivity.
- A nationwide survey of shippers suggests that truck availability for transporting retail and industrial goods has improved significantly.
We do not see, however, gas and food prices improving significantly in the near future. We predict that by the end of the year the inflation rate may be between 4% to 5%.
Economic Vitality
Thanks to the carpe diem philosophy of the American consumer, the economy is strong.
Covid savings by the public during the pandemic was about $2.5 trillion, and the consumer is showing little reluctance to spend much of it. Personal savings rates declined in April by 4.4%, with consumers releasing their pent-up frustration.
Consumers have been shifting their focus by spending more on services than goods. Expenditures on restaurants, hotels, airline fares, and entertainment reflect this change of direction. The economy shrank at a 1.5% annual rate in the first quarter. Many analysts project that the second quarter will see a rise of 3% on an annual basis.
Fear and greed are powerful market movers, and we believe the Chicken Littles are dominating the news. We are living at a time of hyperbole rather than moderation in our communications. The mass media feeds the public with a daily stew of toxic ingredients: runaway inflation, unpredictably rising interest rates, war in Ukraine, Chinese lockdown, non-stop shortages, rocketing wages. These short-order cooks write financial blurbs, appear on cable, make podcasts, and flood the Internet on a daily basis with a tsunami of dire predictions.
Fear sells.
But it also causes the emotional investor to exaggerate current problems and to act out of a gut reaction rather than taking a longer view of the economy and markets. We do not wish for analyses, new opportunities, future projections, and clear thinking to be drowned out by the noise.
Emotional reactions, decisions made from fear, and the power of stress often lead investors to make rash, even foolish, decisions based on temporary market moves and shifting data. This often leads investors to buy at the top and sell at the bottom.
Investors often use the words “stock markets” and “economy” as interchangeable. Obviously, they are related, but they are not the same.
Although all three major indices are down substantially, the U.S. economy remains robust. Employment is strong. The percentage of S&P 500 companies beating EPS estimates is above the five-year average, although at a lower rate.
The Institute for Supply Management Manufacturing Index shows a slowing rate compared to last year but is still expanding. Supply chain shortages should improve in the second half. Many corporate CEOs believe their organizations are doing well.
Employment
People who want to work are working.
Employers are continuing to add to their payrolls. Nonfarm jobs increased to 390,000 jobs in May, above economists’ projections. The unemployment rate remained unchanged at 3.6 percent.
We think this is positive news for the economy. Investors who are selling believe that a tight job market will prevent the Fed from lowering interest rates after June/July. The Fed, however, never stated that it would stop or reduce interest rates after this summer. Nervous investors are assuming something that is not in evidence.
Furthermore, the Fed’s interest rate diligence is the main tool for curbing inflation.
We agree with President Biden’s assessment that May’s jobs numbers show the U.S. is entering a period of sustained economic growth. The job market is currently at its strongest point, according to Biden, since shortly after World War II. Stagflation occurs when there is high unemployment. We are currently the antithesis of that.
Stagflation
If stagflation is a three-legged stool, it is missing two of its legs. Our profound logic tells us that such a stool cannot stand. We do not pretend to be the Delphic Oracle of ancient Greece, whose remarks and answers were infallible. We believe, however, based on fiscal data, economic trends, the resilience of our current economy, and the strength of the job market that stagflation is not a reasonable threat at this time.
