Stagflation: ‘Why Do I Care?’

You can scarcely visit a financial news portal in 2021 without coming across an article about stagflation.

I’d say “you can scarcely pick up a paper,” but nobody reads physical papers anymore. Well, almost nobody. There’s an old bond trader in my neighborhood who does. I’ve mentioned him in these pages before. He has chronic back problems, so he can barely walk. Every evening, he takes a folding chair and makes his way to the beach. For the able-bodied, it’s a two-minute walk — you don’t even think about it. For him, it’s 20 minutes.

I learned years ago that offering to help (by, say, carrying the chair for him) is misguided. Making it there and back gives him a sense of accomplishment in the twilight of his life, his wife later told me. He reads the Journal, but he’s a Democrat. Or, actually, he pretends to be a Democrat because, again according to his wife, he enjoys irritating our neighbors, all of whom are staunch Republicans.

He talks to me about bonds, mostly because that’s all he knows in this world, but also because he knows I’m interested, which is enough. He doesn’t care about my previous occupations, let alone any websites. He just likes bonds. And that folding chair.

He was in the game professionally the last time inflation was “a thing” in the US. He isn’t worried now. In part because, as he put it a few days ago, “Why do I care? I’ve got maybe four years left.” Without wanting to concur with that overtly macabre assessment, I felt compelled to agree. His cadence was insistent. “Good point.”

For a lot of Americans, stagflation matters, though. I don’t know the numbers, but I imagine the percentage of the population that’s both too rich and too old to care about decelerating growth and accelerating price pressures is small indeed. And each passing week seems to bring more data points in support of a return to some mild version of stagflation.

What can we expect from equities? Well, as Goldman’s David Kostin wrote in his latest, there have been 41 quarters over the past six decades during which GDP growth was weak and inflation was high (figure below). Not surprisingly, these periods were concentrated between the late 60s and early 80s.

Not surprisingly, margins fell and rising rates crimped stock returns during stagflationary periods. The median quarterly S&P 500 real return was -2.1% compared to the all-quarters average of +2.5% (figure below).

That’s “worse than the median returns in environments characterized solely by weak economic growth or high inflation,” Kostin went on to say, adding that the main drag is margin erosion.

“Stagflation has been associated with stable real revenues but declining profit margins and real earnings, indicating companies struggling to raise prices quickly enough to offset rising input costs,” Kostin remarked.

Of course, rising rates are conducive to multiple compression, which is insult to injury as profits fall. Goldman described the derating that typically accompanies stagflationary periods as “modest.”

While the media is likely overstating the case (implicitly or otherwise) when it comes to the odds of stagflation setting in for a prolonged period, it’s nevertheless a real risk.

If you ask Mohamed El-Erian, “the only reason we would end up in stagflation is because of a policy mistake.” He spoke to Bloomberg Television on Friday (video below).

“It’s a tail risk,” he said. “Low probability but consequential enough for us to pay attention to.”

I’ll eschew the temptation to be derisive in favor of flatly noting that soundbites from folks like El-Erian are meaningless. It’s all entertainment. Bloomberg is preferable to alternatives, but if you watch it with the sound muted and just read the chyrons, you’re reminded that this is all just a puppet show — the same anchors interviewing the same people making the same arguments.

If they’re right, it doesn’t matter. If they’re wrong it doesn’t matter. It’s just television. Nobody’s going to remember, and nobody for whom stagflation would spell economic ruin is watching Bloomberg Television anyway.

What matters for real people is the effect on families. “Stagflation has historically weighed on not just economic growth but also the growth of household wealth,” Goldman’s Kostin said, adding that household net worth “has grown by a median real rate of 0.5% per quarter since 1960.” During periods of stagflation, that rate is 0%.

As for traders, Kostin casually noted that “US equity investors have had little experience with stagflation in recent decades.” Maybe my neighbor has some tips. Get ’em before they expire.