What Is Stagflation?
What is stagflation and why does it matter to investors? Stagflation is an economic term to describe a situation where economic growth is slower, inflation is higher, and unemployment is relatively high. In simpler terms, stagflation is a situation where inflation is high and GDP (gross domestic product) is declining.
The latter of the two definitions of stagflation may be more relevant as it relates to the first half of 2022. High prices, lower growth, and a stagnant economy was something experienced decades ago during the 1970s. Companies reduced hiring initiatives as rising energy costs directly impacted operating & production costs.
When unemployment is high, consumers generally have less income and spend less. But during stagflation, unemployment might not be a factor as is the case in 2022. The March read out for nonfarm payrolls came in at 431,000 with unemployment dropping to 3.6% according to the U.S. Bureau of Labor Statistics. Among these figures, the number of long-term unemployed (those jobless for 27+weeks) dropped to 1.4 million and accounted for 23.9% of all unemployed people in March 2022.
What Is Inflation?
You might want to know what inflation is in order to better understand stagflation. Inflation is a measure of how much more expensive goods and services have become over a period of time. According to the International Monetary Fund, “To measure the average consumer’s cost of living, government agencies conduct household surveys to identify a basket of commonly purchased items and track over time the cost of purchasing this basket.” These housing expenses also include rent and mortgages.
What Is CPI?
the cost of this “basket” at any one time relative to a specific base year is the Consumer Price Index or CPI. The percent change in CPI over a period of time is known as Consumer Price Inflation and is the measure that most use to identify actual Inflation. One example that the IMF gives is this:
If Base Year CPI is 100 and the current CPI is 110, inflation is 10% over that period
Is there a different between consumer price inflation and consumer price inflation? Core focuses on more static trends in inflation. It removes prices set by the government and watched closely by policymakers.
Why Does Stagflation Matter?
Whether we’re talking about penny stocks or stocks over $100, inflation and stagflation matter in the longer-term. Sure, you’ve got individual companies that go against the broader trend. But when there are sweeping economic trends, if the trend is your friend, you’ll want to know the factors in play. Stagflation can be attributed to several things that result in rising costs and, in turn, lower rates of production.
Oil prices are one of the core points of interest when economists view stagflation. As we’ve seen as a result of the Russia-Ukraine conflict, international sanctions on Russian oil have put a strain on the oil market. Looking back at the 70’s, OPEC (the Organization of Petroleum Exporting Countries) put embargos on Western countries causing a rise in global energy prices. This created a snowball effect that hurt transportation thanks to rising fuel costs, which made consumer goods cost more to stock shelves. Ultimately, this lead to layoffs, which further contributed to the economic theory itself.
In the 1970’s there were also factors related to monetary and fiscal policies that added to the situation. The Fed Chairman at the time, Arthur Burns eased monetary policy in response to higher commodity prices. This allowed inflation to continue.
Stagflation can also put pressure on bond prices, while also muting valuations. Households earn less money. Yet another snowball effect comes to light as slower spending that results, can impact corporate revenue and expand the overall impact across global economies.
Example of Stagflation: The Nixon Shock
The best example of stagflation came during the Nixon era, which saw the U.S. remove itself from the gold standard. It also saw a 90-day freeze on waves and prices along with a 10% tariff on imports. Attempting to combat stagflation, the Federal Reserve raised the Fed Funds Rate to fight inflation but then lowered it to combat a recession. This start-stop policy strategy didn’t help the overall economy and ultimately increased inflation altogether. In addition, OPEC’s oil embargo on the US triggered price spikes in energy. Businesses passed this cost along to consumers, while also curbing production. A recession then ensued in the early 1980s to eventually reduce the spiralling inflation.
As you’ll see on the S&P Index chart below, the period between the end of 1971 through 1982 saw declining market prices. Since the S&P 500 ETF (NYSE: SPY), Nasdaq ETF (NASDAQ: QQQ) and Dow ETF (NYSE: DIA) weren’t “born” yet, we’ll go directly off of the SPX:
The hope right now is that those in charge of economic policy and have a better handle on current conditions than was the case 4 decades ago.
Will Stagflation Come Back In 2022?
Excessive money printing, rising energy prices, economies still recovering from the pandemic, supply chain constraints, sanctions on Russian products, geopolitical unrest, and more are commanding headlines right now. Is the world in for another recession? Will inflation turn into stagflation? What comes next?
This week’s CPI data is causing significant economic uncertainty in already fragile conditions. CPI rose 8.6% in March, which was slightly higher than analyst expectations of 8.4%. This was also the highest increase in rate since 1981. Month-over-month, CPI was also up 1.2%. Peeling back the data shows food prices jumped 1% MoM and 8.8% YoY. Auto prices, however, actually dropped roughly 3.8% MoM despite being up significantly (~35%) YoY. Now the question is: Have we reached peak inflation and is there any chance of stagflation?
As the Federal Reserve begins increasing rates in a high inflationary environment and supply chain issues persist, it presents a unique situation. “Bond king” Bill Gross recently told CNBC that he thinks the Federal Reseve is “sort of handcuffed in terms of what they can do” because of prior monetary policy decisions. He explained that he sees a possibility of stagflation. Will Gross be correct in this hypothesis?
Are You Worried About Stagflation?
Whether it’s inflation, stagflation, or something else, any negative impact to economic growth is concerning. The important part is to understand what factors are in play during periods like this and knowing how to navigate the stock market effectively. Even in the event of a stock market crash, there are ways to continue making money. You just need to have an idea of where to look for opportunities. Now that you have a basic understanding of stagflationary metrics, is it something that concerns you or do you know how to plan for it and profit from it? Leave us a comment below.