Stagflation Fears Rise: Wall Street Divided on Economic Outlook
1970s Concerns Resurface as Stagflation Debate Dominates Wall Street
As inflation surges to levels not seen since 1990, a familiar economic concern is gaining traction among investors and financial strategists: stagflation. Chief Equity Market Strategist at Federated Hermes, Phil Orlando, is increasingly convinced that the current economic environment is mirroring the conditions of the 1970s, a period defined by stagnant economic growth and stubbornly high inflation. This resurgence of the “stagflation” debate is prompting investors to re-evaluate their portfolios and bracing for a potentially challenging period.
The parallels with the 1970s are striking. Consumer prices rose at an annual pace of 5.4 percent last month, pushing inflation past 1990 levels, fueled by surging commodity prices and substantial U.S. fiscal stimulus implemented since the start of the pandemic. Simultaneously, projections indicate a slowdown in U.S. economic growth to 2.7 percent, a significant deceleration from the prior quarter’s 6.7 percent rate. This combination of rising inflation and slowing growth – the very definition of stagflation – is forcing a strategic rethink among investors.
The debate isn’t without dissent. Many on Wall Street believe comparisons to the 1970s are overblown. They argue that the drivers of current inflation are different, less persistent, and likely to dissipate. However, the volume of concerns is rising dramatically. Google searches for “stagflation” reached their highest level since 2008 this month, demonstrating a heightened level of awareness and apprehension. Goldman Sachs reports that “stagflation” is now the most common word in client conversations, reflecting a widespread anxiety. Furthermore, surveys reveal that a significant portion of fund managers now believe the risk of stagflation is real, with the number of managers expecting it rising by 14 percentage points in October to the highest level since 2012.
Investors are reacting to this perceived threat by adjusting their strategies. Louis Navellier, Chief Investment Officer for Navellier & Associates, anticipates a “tunnel” scenario characterized by increased market nervousness and a narrowing of trading ranges. He plans to tighten portfolio positions, focusing on companies capable of passing on rising costs, such as energy and industrial firms. Investors are also looking for relative safety, with many diverting funds to holdings like Target Inc., big-box retailers with established supply chains.
The historical record during periods of stagflation is sobering. Across 60 years, the S&P 500 experienced a median decline of 2.1 percent during quarters marked by stagflation, while it rose by a median of 2.5 percent during all other periods. Bonds also struggled, particularly during the late 1960s and 1970s. Spiking oil prices, rising unemployment, and loose monetary policy pushed the core consumer price index to a high of 13.5 percent in 1980, prompting the Federal Reserve to raise interest rates nearly to 20 percent. The benchmark 10-year U.S. Treasury fell in nine of the 11 years leading up to 1982. Inflation erodes the purchasing power of bonds’ future cash flows.
Phil Orlando of Federated Hermes is advocating for investments in companies that can withstand economic headwinds. However, the pivotal question remains: will the Federal Reserve respond aggressively to curb inflation – a move that could further slow economic growth? The central bank is set to begin unwinding its US$120 billion-a-month government bond buying program, and signs of a faster taper or more aggressive interest rate increases would likely weigh heavily on the stock market. Jason England, Global Bonds Portfolio Manager at Janus, emphasizes that if inflation levels remain elevated and growth hasn’t picked up, the Fed will undoubtedly take action.
Despite the prevailing concerns, some analysts maintain a more optimistic outlook. Scott Kimball, Co-Head of U.S. Fixed Income at BMO Asset Management, believes that most of the spending in a potential infrastructure bill – a significant worry for inflation hawks – is long-term and would not have an immediate impact. Jean Boivin, Head of the BlackRock Investment Institute, predicts accelerated growth as supplies become more readily available and remains “pro-risk,” arguing that the inflation pressures expected are already present, but unlikely to lead to stagflation. Ultimately, the future trajectory of the economy and financial markets hinges on the interplay between inflation, growth, and the Federal Reserve’s policy response – creating a complex and potentially volatile environment for investors.
