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Why Stagflation Isn’t in the Cards

Why Stagflation Isn’t in the Cards

August 12, 2021
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The term stagflation has been increasingly circulating in the financial media as inflation readings have risen sharply in recent months. The term is often associated with the 1970s which saw runaway inflation—largely driven by sky-high energy prices—and lackluster economic growth. One way to gauge stagflation is to calculate what is commonly referred to as the Misery Index—inflation plus unemployment.

As shown in the LPL Chart of the Day, the Misery Index today is nowhere near the extreme levels of the 1970s. In fact, not only that, the level of “misery” is near the long-term average of about 10 despite the highest inflation readings we’ve seen in over a decade. We expect inflation to soon begin to ease and the unemployment rate to continue its steady decline over at least the next year, which should bring this measure well below its long-term average and put an end to the stagflation fears that have been bubbling up recently.

See enlarged chart.

“We don’t believe the current environment is anything like the stagflation experiences of the 1970s,” explained LPL Financial Director of Research Marc Zabicki. “We think much of the elevated inflation readings we’re seeing now are transitory and related to pandemic bottlenecks and materials shortages. Meanwhile, the economic reopening and massive stimulus should provide a strong one-two punch to keep economic growth well above average through 2022.”

That said, after the boosts from the reopening and stimulus pass, the U.S. economy may resume its pre-pandemic growth trend in the neighborhood of 2% real gross domestic product (GDP) growth. Bloomberg’s survey of economists points to just 2.3% real GDP growth in 2023, after 4.2% next year. Given the limited population growth in the United States, demographic headwinds as baby boomers retire, and low immigration rates, the opportunity for stronger economic growth than that may be limited.

The other way to drive higher economic growth is through productivity enhancements which may also be tough to come by after all of the technology spending and efficiency improvements undertaken by corporate America during the pandemic. Slower growth isn’t necessarily a bad thing, as it tends to keep inflation at bay which can limit increases in interest rates. But it may mean slower earnings growth and potentially lower stock returns over the next several years.

For the short-to-intermediate term, we remain comfortable staying overweight equities relative to fixed income. The economic growth and profit environment looks very favorable for the rest of this year and into early 2022, while we do not expect much return out of the bond market (though we like mitigating downside risk with bonds).

Clearly there are risks in terms of the Delta variant. China’s regulatory crackdown and slowing growth is a concern. Our benign view of inflation could be wrong The Federal Reserve could make a policy mistake, causing interest rates to surge. Not our view, but possible.

 

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy. All index data from Bloomberg. This Research material was prepared by LPL Financial, LLC. Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

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