Are We Headed for Stagflation?
Stagflation is the combination of high inflation and a slowing economy. Lately, the question above has come up more often and there has been increased chatter about the likelihood of a recession. While the probability of a recession has ticked up in recent weeks, a downturn in the economy is definitely not a sure thing. Here are a few things to consider about the state of the economy right now:
The bad news
Higher inflation is likely going to stick around for a bit longer than expected at the first of the year. This change in calculation is due to the Russia-Ukraine conflict and unresolved supply issues. Supply production continues to be interrupted with our trade partners and this continues to be a problem for getting inflation under control. This week a new shutdown in China indicated that we may continue to see manufacturing interruptions for some time. The Ukraine-Russia war has added a price spike in commodities like oil, wheat, corn and nickel. These drivers of high prices have started to put a dent in consumer confidence as the staples like fuel and food have become more expensive. The consumer remains to be the driver of the U.S. economy, accounting for about 70% of U.S. GDP. So, a lag in consumer demand would be the main issue that could slow economic growth.
The good news
The U.S. is a net exporter of energy. We are in a good trade position when it comes to oil and coal, and I heard an analyst refer to us as the “Saudi Arabia of natural gas”. This means that while high oil prices are really hard on most of us, not everyone is hurting. American oil companies are benefiting which is good for our economy. This positive for energy producers can act as an offset to a lag in demand.
The U.S. consumer was in really good shape coming into this year and numbers are showing that demand is still strong. I recently saw a comical meme on social media that said: “Covid: You can travel now…Oil prices: The h*** you can” I thought this was pretty appropriate based on many discussions that I have been having. Many people are excited to get back to travel and leisure after 2 years of caution. This pent-up demand may continue to produce good economic benefits.
Growth has been really strong. In our 1st quarter market and economic outlook, we showed that economic growth expectations were 3.5% to 4.5% for 2022. These projections are well above the 1.5 – 2% growth that we have experienced over the last 20 years. This means that while actual growth may be lower than expected, it may not be recessionary.
The big picture:
The occurrences of high inflation and war in Europe are disturbing. We are feeling the effects in our financial markets right now and this can’t be sustained long-term. If we take a step back from the immediate results, we can see a positive outlook. Here are some charts to consider:
As a global economy, we are all interconnected. However, the U.S. has very low exposure to imports from Russia and Ukraine. This means that there is more danger for Europe as they rely on Russia much more for trade. We are seeing that play out in market returns so far with European markets suffering more that U.S. so far this year.
The proportion of energy consumed by the U.S. consumer has been going down. This lessens the effect when we see a spike in oil prices. Consider the mpg estimates of cars that are purchased today vs. those in the 70s.
Most economic indicators are still healthy right now and we are not seeing high recession indicators other than inflation.
Keep in mind that the economy is not the market. Often, we see the market react before a slowdown in the economy which results in a bottoming before we see the business cycle turn into a recession. If we look at history, we can see that market performance around negative geopolitical events has been positive as we move away from the initial negative shock.
We hope this helps put things into perspective. We are monitoring economic indicators closely and we post a summary on our blog every Monday.
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