It may feel similar, but the differences are many.
Bellbottoms and flare pants, fringe accents, bell sleeves and paisley prints were all the rage in the 1970s. Vinyl records, too. I was in high school and college that decade and it was a blast. For our parents and investors? Not so much. Vietnam. Watergate. Two oil embargoes. Two recessions. America held hostage. Inflation—consumer prices rose an average 7.4% a year over 10 years. Stagflation—four of the 10 years saw negative real GDP prints. And a go-nowhere market—average annualized S&P 500 price returns of 1.6% (though thanks to dividends total returns averaged 5.8%).
Could it be happening again? Some of the fashions are making a comeback. Records, too. Dividends are now “in.’’ But also, inflation. Headline and core price increases are at 40-year highs and broadening, abetted by war-driven shortages, Covid-related supply chain breakdowns and issues (peak globalization) that can’t be quickly fixed. Food prices are soaring, home prices too—they’re at record highs. And wages are rising at their fastest pace in decades as the pool of available workers continues to fall short of demand. Good for workers, worrisome for corporate profits.
These sorts of structural pressures typically fade slowly, prompting the market to start pricing in potential stagflation. Indeed, the 5-year breakeven rate (the spread between inflation-indexed and nominal Treasury yields) hit new highs last week despite the Fed’s aggressive rate-hike path. All this has consumers in a mood. Even with near-record low unemployment and strong job growth and household balance sheets (financial obligations to disposable income are at a 42-year low and household net worth in real terms climbed nearly 20% in the last two years—unheard of so soon into a recovery), present conditions in the latest Michigan sentiment survey hit lows seen only twice in the past 40 years (the 1980 energy crisis and 2008 global financial crisis). Blame inflation fears.
This is not the ’70s … yet. For one, labor demand is outstripping supply, allowing many workers to be choosier and keeping upward pressure on wages (and inflation). In the ’70s, the upward pressure on wages was due to the strength of unions, not a lack of labor supply. We’re living in unusual times, with unprecedented so common—monetary policy, fiscal policy, pandemic, war in Europe—that it’s no longer unprecedented. That said, labor participation by prime-age workers is recovering at a record pace. A move back to pre-Covid engagement in this cohort would boost labor supply by about 1.3 million, helping to offset some of the so-called “Great Resignation” during the pandemic that saw 3.3 million workers voluntarily drop out, the vast bulk retiring boomers. Lower-skilled and entry-level jobs that disappeared with the lockdowns (and amid generous Covid benefits) are returning as those benefits evaporate and America reopens.
Problematic inflation requires a wage-price spiral. We should not take this lightly. Empirical Research notes demand for workers is robust in most industries. The number of unemployed per job opening is at a 7-decade low, and so too is the rate at which open positions are being filled. Supply is being held back by a series of factors, including the aforementioned retirement of baby boomers. For the first time since the ’70s, the trend rate of unemployment is well below the natural rate (the minimum absent transitional and voluntary reasons), reflecting weak supply and perhaps the somewhat different priorities regarding work of the younger generation. The labor market is structurally tight, and that argues inflationary pressures will prove harder to wrench from the system than many believe. But to have stagflation, the economy needs to be stagnating. At present, there’s little evidence of such. Less than 10% of new housing inventory has been completed, meaning residential construction has years to juice economic activity. Based on capex trends, the same holds for business and industrial structures. Moreover, the nature of the economy is quite different from the ’70s. Back then, manufacturing and mining accounted for about a quarter of GDP; today, it’s half that.
Rooting for productivity to save the day. Unlike the ’70s with its stagnant capex and productivity, this decade is seeing acceleration in both. Productivity surged at a 6.6% annual rate in 2021's fourth quarter, the second-fastest rate in dozen years, just behind the 10.2% annualized surge in 2020's second quarter when the economy was coming out of the first-quarter’s self-imposed shutdown. There are reasons to believe this upward trend will continue as companies, facing global trade bottlenecks and geopolitical conflicts, as well as structural wage pressures, look to inshore supply chains and automate whenever possible. Rapid advancements are seeing artificial intelligence and robotics increasingly insert themselves in all aspects of business. This is far different than in the ’70s, when annualized productivity fell to 1.5%, half its level in the ’60s. Arguably an even larger force is at work. Just as baby boomers were entering their prime work years in the late ’70s-early ’80s, helping fuel a prolonged period of falling inflation, an even larger generation—the millennials—are entering prime working years now. Their average age is 31.5. Right behind them is the nearly equally large Gen Z generation. That’s our holy grail. We wish them Godspeed.
Midterm elections are coming With state and federal taxes on average accounting for 22% of the price at the pump, at least 21 states are seriously considering cutting their gas tax. Others, including California, are weighing gas tax rebates. The moves come as gas prices continue to hover at nominal record highs.
Midterm election panic “One of the greatest tax reform movements in our lifetimes,” as Strategas Research puts it, is quietly underway. At least 21 states cut taxes last year, five more plan cuts this year and two, Kentucky and Mississippi, are looking to eliminate their income tax altogether. Colorado’s Democratic governor has suggested doing the same. Also, Iowa cut and shifted to a flat tax.
The great Covid income migration A separate Strategas study found high-tax states experienced a 76% increase in income outmigration compared to 2019, while low-tax states saw a 25% increase in income from domestic in-migration. Income migration was measured in aggregate dollars and as a percentage of a state’s income, with Florida the runaway winner, gaining $37 billion of new income over the last two years. At $10 billion, Arizona was a distant No. 2. California and New York were the biggest losers.