Stagflation ... Pshaw! Stagflation ... Pshaw!\images\insights\article\roller-skates-small.jpg October 15 2021 October 15 2021

Stagflation ... Pshaw!

This is not the 1970s ... not even close.

Published October 15 2021
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“Stagflation is all anyone in markets wants to talk about now,” Bloomberg News reports. Google searches for the term have more than doubled. Market professionals surveyed by Deutsche Bank say it’s here, though they couldn’t agree on what it is exactly. Their average age is 45. They’ve never experienced real stagflation. I have and here’s what it looks like: double-digit inflation, plodding growth and rising unemployment. What the economy is experiencing now is not stagflation but an inflationary boom. Prices all over are up—gas, food, cars, etc.—and there’s an honest debate over whether some of these will prove temporary or structural. Burdened by the delta variant’s summer spread, GDP growth is certain to sharply decelerate in Q3, the first slowdown of this still-young expansion. But this is not the ’70s, when globalization was just an idea and OPEC oil embargoes and labor strikes were common in our heavily unionized, imported oil-dependent country. None of this is the case today. With the delta variant rolling over, payrolls and activity are re-accelerating while some pandemic-driven price increases are moderating. Market and survey-based inflation expectations remain contained. Stagflation? Pshaw!

No surprise Q3 challenged the market. Going back to 1960, quarters marked by slowing growth and rising inflation saw negative real returns on the S&P 500. Earnings expectations for the Q3 reporting season that began this week had been stagnant for a couple of months after rising for most of the year—the -28% difference between August and September upward revisions was the largest decline in the history of the series dating back to 1985. Notably, earnings-per-share revisions hit their lows for the year in the most economically sensitive stocks. But Value names are off to a good start thanks to big banks that report early. And Q3 earnings growth, while not blockbuster like Q1 and Q2, is still expected to be strong on easier comps vs. a year ago. So far, Credit Suisse says earnings are beating estimates by more than 11%. Guidance for 2022 is likely going to play a big role and Bank of America thinks it “could be ugly,” with downward revisions likely on supply bottlenecks, rising wages, a slowing China, soaring commodity prices, etc. There’s been little talk on earnings calls so far about tax increases even though corporate tax changes, if adopted as expected, could swipe 4% off S&P earnings growth in 2022. The story continues to be one of continuing, if milder, earnings growth. Margin pressures appear muted, so far, with many companies saying they’ve been able to pass on input price increases.

Another surge in Covid-19 cases seems unlikely. Vaccinations are rising on boosters and mandates, with availability to children coming soon amid more natural immunity than last year and no super-spreader national election. This supports an acceleration of growth in the months ahead. Household balance sheets have deleveraged, labor markets are strong (more below) and savings are elevated, all positives for spending growth through the holidays (if shoppers can find what they want) and beyond. This morning’s retail sales report shows consumers aren’t slowing down (more below). This spending, combined with increasing capex and multi-decade lows in inventories, should drive a strong cyclical recovery into next year amid gradually fading supply headaches. Slowing Covid-19 cases already are feeding a revival in services activity and reopenings. OpenTable reservations and air traffic are trending up again, homebuilding is starting to pick up and Evercore ISI surveys show state sales tax receipts rising to a 15-year high and early October strength in retail activity. With the pillars of the bull intact, it thinks a breakout above 4,460 on the S&P (at this writing, it has just topped that level) could unlock a powerful year-end push. Our own expectation is 4,800 on the S&P by year-end.


  • Delta schmelta September retail sales surprised, rising more than triple consensus, and August’s already robust sales were revised further up. Some of the increases reflect higher prices, which are rising too. But spending growth was broad across categories, reflecting American shoppers who are looking past their feelings (the latest Michigan sentiment reading fell again on delta variant worries, supply shortages and D.C. drama) to do what they do best.
  • Peak inflation? Core readings of September’s CPI and PPI reports suggest inflation is starting to normalize, as pandemic-impacted sectors that drove up CPI are starting to pull back, including used-cars & trucks, airfares, car & truck rental prices and lodging. Cornerstone Macro expects goods demand (ex-autos) and thus prices to soften, too (the cure for higher prices is higher prices). Combined with tough 2021 comps, it thinks the effect could drive headline inflation down to 1% by year-end 2022.
  • People not at work due to illness That’s the Labor Department’s classification for the nearly half million who stayed at home in August and September due to delta, causing payrolls to significantly miss forecasts. Now that the variant is fading and bonus unemployment benefits have ended, there are signs payrolls are re-accelerating. This week saw nice beats in initial and continuing claims. Both hit new post-Covid lows, dropping the implied jobless rate to just a point above its 3.5% pre-pandemic low.


  • Small businesses see stagflation Headline NFIB optimism mildly disappointed, but the details were troubling—the net percentage of small business owners expecting better business conditions dropped to negative 33%, one of the lowest readings on record. And the net percentage planning to raise prices rose to 46%, just off 1979’s all-time high. Small businesses represent nearly half of private GDP and over half of employment.
  • Some not-so-good inflation news September saw the biggest rise in owners-equivalent rent—a housing cost indicator that accounts for nearly a quarter of CPI—since the 2006 housing bubble. The highly visible food and energy segment is now tracking at +29% annualized for the meats, fish and eggs basket. And gasoline and oil prices hit 52-week highs, followed closely by heating oil and jet fuel. So, while we may be past peak inflation, categories that consumers notice continue to run hot.
  • From “transitory” to “permanent” From January to May, the 2-year breakeven inflation rate rose to a peak of 3.2%, more than the 10-year breakeven inflation rate, which only rose to 2.5%. This suggested that investors expected inflation to be elevated for only a short period of time. Since May, however, the 2-year breakeven inflation rate has fallen while the 10-year breakeven inflation rate is testing recent highs. Gakeval Research says this indicates investors believe persistent inflation is the new reality.

What else

Beware “inflation-proof” portfolios Allocating $100 in 1974 to an “inflation” basket of commodities, gold, global Value stocks and European equities would be worth $390 today, Bank of America says. An allocation to “deflation” via investment-grade bonds, Treasuries, U.S. growth stocks and the S&P 500 would be worth $1,080.

Technicals tired of Growth, large caps and tech Growth and large caps are trading near 20-year highs relative to Value and small cap valuations, respectively. At the sector level, tech valuations appear quite stretched vs. cyclicals, non-cyclicals and financials, which are trading at relative discounts to the market.

This has moderates nervous A weak Q3 GDP report could fall just before the tight Virginia gubernatorial election. A Republican win there would be a political earthquake in Washington. Even if the Democrats win the governor’s race by 5 percentage points, that would be a big shift from 2020 when Biden won the state by 10 percentage points.

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Tags Equity . Markets/Economy . Inflation .

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