Stagflation has arrived - what should we do? (2024)

FAQs

How did we get out of stagflation? ›

The stagflation became more severe in the early 1970s but was suppressed by the price controls and wage freeze imposed by President Nixon starting in August 1971 and through 1972.

Investing in bonds and credit is a good way to protect your investment portfolio against stagflation, high inflation, a recession, and market volatility. For example, floating-rate bonds adjust their interest rates with the change in the CPI (Consumer Price Index) - providing higher inflation protection.

Stagflation is a stagnant economy combined with high inflation. Stagflation amounts to a killer combination and can result in an economic downturn in which bills and the cost of living keep rising.

Historical data from previous periods of stagflation show us that gold, energy stocks, agricultural stocks, and real estate, in particular, are the top performers during stagflation.

Foreign bonds may do better than domestic bonds when stagflation sets in. Cash and cash equivalents. Cash and cash equivalent investments face the same problem as bonds during periods of stagflation. The returns they generate may not be enough to keep up with rising consumer prices, siphoning away purchasing power.

Stagflation in the 1970s combined high inflation with uneven economic growth. High budget deficits, lower interest rates, the oil embargo, and the collapse of managed currency rates contributed to stagflation.

Gross Domestic Product (GDP)

The report sets overall 2022 U.S. economic growth at 2.6%, which makes it pretty clear that the U.S. was not in a recession in 2022. However, Bill Adams, chief economist for Comerica Bank, believes that GDP will likely slow sharply in early 2023.

Stagflation is a situation where the economy is not growing, but prices are rising, and there is high unemployment. Stagflation is generally considered worse than a recession because it is a much more challenging economic condition to manage.

In the 1970s, part of the stagflation was caused by rising wages (powerful trade unions). A policy tried was wage control – government intervention to limit wage rises. In theory, limiting wage increases can break the cycle of wage inflation and help to improve the economic situation.

According to research by the World Gold Council, the winners during periods of stagflation between 1973 and 2021 were “defensive assets and real assets, in particular gold, while equities have suffered the most followed by a mixed performance from fixed income.” Remember that analysts may be wrong.

Should you invest during stagflation? ›

Find high-performing stocks during Stagflation

To survive periods of Stagflation, investors should perform due diligence on their portfolios so they can stay ahead of the curve. By investing in a diversified portfolio of growth and value stocks, you should be able to weather the storm.

It is often accompanied by high unemployment rates, rising costs and a fall in the nation's gross domestic product (GDP). Stagflation affects consumers by decreasing their purchasing power, which can drastically slow down an economy's growth.

Our Research analysts see a challenging new phase for the world economy in 2023: slowing growth and lingering inflation, also known as stagflation.

However, during periods of stagflation, real estate returned 5.5% in real terms while equities returned 2.5% and government bonds -7.3%. In our view, the biggest threats to real estate markets are periods of recession combined with inflation at average or below average levels.

Stagflation and real estate

When the economy stagnates and the inflation rate is high, this has a negative impact on property prices. Therefore, during stagflation, it can be difficult to sell your property for a profit, especially because you'll still have to pay capital gains tax.

Some of the most common types of safe assets historically include real estate property, cash, Treasury bills, money market funds, and U.S. Treasuries mutual funds. The safest assets are known as risk-free assets, such as sovereign debt instruments issued by governments of developed countries.

For example, the top performers during periods of stagflation have been gold (+22.1%), commodities (+15.0%) and real estate investment trusts (REITs) (+6.5%). Equities have tended to struggle (-1.5%). This makes sense. Gold is often seen as a safe-haven asset and so tends to appreciate in times of economic uncertainty.

Excess cash has 3 negative impacts:

It lowers your return on assets. It increases your cost of capital. It increases overall risk by destroying business value and can create an overly confident management team.

The best option for keeping up your personal finances when inflation rises is to keep a percentage of your money in long-term investments as part of a diversified portfolio. Retirement accounts, for example, are commonly used as a way to grow your money slowly over time and keep up with the natural rise of inflation.

Carter took office during a period of "stagflation," as the economy experienced a combination of high inflation and slow economic growth. His budgetary policies centered on taming inflation by reducing deficits and government spending.

Will the US face stagflation? ›

An overwhelming majority of Wall Street investors anticipate that stagflation will pose the biggest risk to the global economy in 2023, continuing to create volatility in the stock market, according to a recent Bank of America pulse survey.

Jimmy Carter (1977-1981)

His presidency had by far the highest GDP growth, more than 1% higher than President Joe Biden thus far. But he also had the highest inflation rate and the third-highest unemployment rate.

Many economists believe the strategy will trigger a recession this year. But the NABE forecasters expect the economy to grow 0.8% in 2023 – based on the change in average GDP over the four quarters compared with 2022. That is down from 2.1% last year but up from their 0.5% estimate in December.

In a best-case scenario, the U.S. will likely see a 'soft landing' with low/slow growth across 2023 before picking up in 2024. However, a downside scenario is a real possibility and could see the U.S. enter a prolonged recession lasting well into 2024, as is currently forecast for the UK and Germany.

Advanced economies are expected to see an especially pronounced growth slowdown, from 2.7 percent in 2022 to 1.3 percent in 2023. In a plausible alternative scenario with further financial sector stress, global growth declines to about 2.5 percent in 2023 with advanced economy growth falling below 1 percent.

Is it possible to avoid stagflation? Avoiding stagflation is difficult, because financial regulators have to balance two competing interests: inflation and unemployment. Dealing with inflation usually involves hiking interest rates, making it more expensive to borrow money.

One asset class investors flocked to was commodities. The S&P GSCI Index, a measure of commodities investment performance, returned 586% between 1970 and 1979.

1965–1982. The Great Inflation was the defining macroeconomic period of the second half of the twentieth century. Lasting from 1965 to 1982, it led economists to rethink the policies of the Fed and other central banks.

Is cash king during the recession? ›

The phrase means that having liquid funds available can be vital because of the flexibility it provides during a crisis.

However, during stagflation, more people are out of work, and wages are not increasing, so customers can't afford to pay higher prices. At the same time, businesses often experience labor disruptions during stagflation, as employees seek higher wages in the face of increasing costs.

Stagflation is a real problem for policy makers because the Central Bank can increase interest rates to reduce inflation or cut interest rates to reduce unemployment. It cannot, however, do both at the same time.

As a recession in the US remains a possibility, US stock exchanges may continue to struggle at the start of 2023. And for this reason, some banks and analysts are forecasting stock exchanges to continue to lose value in the first half of the year.

In the first half of 2023, the S&P 500 is expected to re-test the lows of 2022, but a pivot from the Fed could drive an asset recovery later in the year, pushing the S&P 500 to 4,200 by year-end.

For example, during a period of stagflation, a central bank could raise interest rates to fight inflation. But this would hurt the struggling economy. And the central bank could lower interest rates to stimulate the economy, but this would exacerbate inflation.

So, the U.S. is not experiencing stagflation now. Reversing high consumer prices requires a tricky balance of government intervention: putting the brakes on the U.S. economy just enough to ease consumer demand without falling into a recession or triggering stagflation.

Stagflation happens when inflation exists in tandem with slow economic growth and high unemployment. Typically, these economic conditions don't occur together. Unemployment and inflation tend to be inversely correlated. So, as unemployment rates increase, inflation usually decreases and vice versa.

The Policy Response

The Keynesians of the 1970s hoped that increased government spending and lower interest rates would counter downturns in aggregate demand and relied on the Phillips Curve, which describes the typically inverse relationship between inflation and unemployment.

How did 1970s inflation end? ›

The Fed tightened monetary policy while at the same time increasing the money supply. The inflation rate dropped to 5 percent in 1976, and the economy emerged from recession.

Growing deposits will be a priority in 2023. Banks' concerns over small business deposits soared to 72% from 41% in 2022. For credit unions, retail deposits topped the list, skyrocketing from 18% in 2022 to 70% in 2023.

As the Federal Reserve began raising interest rates in 2022 in response to the 2021–2023 inflation surge, bond prices declined, decreasing the market value of bank capital reserves, causing some banks to incur unrealized losses; to maintain liquidity, Silicon Valley Bank sold its bonds to realize steep losses.

Inflation rates are expected to drop around the world in 2023, thanks in large part to weaker demand and some easing of kinks in supply chains. Nevertheless, our Research analysts think inflation will remain above central banks' 2% targets by the end of the year.

For bonds, this correlation between positive real returns and their ability to keep inflation down was very strong. Another good place to be in the 1970s were precious metals, with gold and silver seeing strong real returns as they lived up to their reputation as an effective inflation hedge.

Consumer spending kept GDP barely above zero at 1.1%. 2023 Q2 will likely print at half that or lower on a glidepath to recession. But the second half recession won't kill inflation; it likely will result in "stagflation."

Nixon issued Executive Order 11615 (pursuant to the Economic Stabilization Act of 1970), imposing a 90-day freeze on wages and prices in order to counter inflation.