The term stagflation seems to have returned to the economic debate to stay for a while. The combination of stagnation and high inflation it is leading experts and laymen alike to look back and look at the 70s and 80s of the 20th century.
The US Federal Reserve updated its forecasts for this year on Wednesday, raising inflation forecasts from 2.6% to 4.3% and lowering growth forecasts from the 4% estimated in December to 2.8%. The reading is clear and although the president of the organization, Jerome Powell, wanted to give a message of confidence, investors look to history to see how Wall Street weathered turbulent times similar.
In the 1960s, US inflation rose throughout the decade from 1% to 5% due to the strength of the national economy, as well as spending on the Vietnam War and new social programs. The 1970s came with a recession in late 1969 and ‘ended’ with another in 1982. The US economy was going through a long period of stagflation.
Inflation increased throughout the decade and was always higher than GDP growth. Fed Chairman Paul Volcker ended the era of stagflation by beginning the 1980s by raising interest rates enough to trigger a deep recession. This finally broke the inflationary momentum of the economy after more than a decade of CPI increases above 5% year-on-year.
Seeking to shed some light, the analysts and founders of DataTreak, Nicholas Colas and Jessica Rabe have published a note in which they study how Wall Street behaved in this period. The first thing they do is highlight something relatively obvious when looking at the data: the performance of the S&P 500 between 1970 and 1982 was very volatile And not just because of stagflation. If in 1972 it gained 18.8%, in 1973 it lost 14.3% and in 1974 25.9% (through the oil crisis) to recover 37% in 1975.
The analysts’ second step is to highlight something not so obvious: “Even with all that volatility, the S&P 500 kept pace with CPI inflation during the stagflation of the 1970s and early 1980s. It didn’t beat the index.” of consumer prices by a lot, but it held its value. If between 1970 and 1982 the IPC advanced 159%, the S&P 500 did 169%.
At this point, both experts take a parenthesis to note that, “although there is a popular belief that the US residential real estate sector did exceptionally well during the stagflation period of the 1970s and early 1980s, the historical data set on Robert Shiller’s house price says otherwise.” From 1970 to 1982, the average US home appreciated 159%, exactly the same as CPI inflation. “House price appreciation was never negative during this period, but it was below 1% per year during the 1973 and 1982 recessions,” they add.
“The reason US stocks kept pace with inflation during this period boils down to two words: business benefits“, underline Colas and Rabe. As verified in the graph attached to the note, the profits of US companies before taxes tracked dollar-for-dollar CPI inflation from 1970 to 1982. They were even well above inflation until the recessions of 1980 and 1982 reduced corporate profitability.
In viewing stagflation as a threat to stock prices today, DataTreak’s founders argue, it’s important separate the recession effect of the 1973 and 1974 oil shock from the rest of the historical record for the period 1970-1982. The 1973-74 recession had a devastating effect on share prices.
On the contrary, they add, subsequent persistent inflation greatly helped corporate profits and had a beneficial effect on equities. “Put another way, if a smart investor had stayed out of equities in 1973-1974, but invested fully in 1970-1982, he would have far outperformed inflation during a period of US economic history. which, moreover, was stagflation”.
This leads Colas and Rabe to the ultimate conclusion: “Recession – not stagflation – is therefore the real risk for US stocks right now.” How does this translate to the immediate horizon? “On the one hand, this is reassuring. The US economy remains strongjob openings continue to far outpace the number of unemployed workers, and supply chain constraints should start to ease later this year.”
On the other, however, they stress, “we have high oil prices due to geopolitical shock (reminiscent of 1973 and 1979) and a Fed determined to raise rates to reduce inflationary pressures.” “Has inflation ever dropped significantly without a recession occurring once it’s above 5%?” they ask. “No, it hasn’t,” they reply. themselves by referring to the first graph. tension between these two points It will not be resolved soon, so we expect the volatility in equity markets to continue.”
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