What Did We Learn This Week? (11/11/2022)–Mild Stagflation

Mild Stagflation

What did we learn this week?

We learned that market expectations and positioning were not for a downside print for the CPI. Within 5 minutes of the report, S&P futures were up 3%, the ten-year yield sharply crossed back below 5%, the dollar dropped, and cryptocurrencies rose from the dead like zombies. I’m not sure we learned much else.

I have no doubt that inflation will continue to decline for all the reasons we already knew. The US as well as the global economy continues to decelerate. The Fed got a late start, but we know they haven’t been shy about trying to catch up. The Fed is engineering a recession, which is unfortunately, the only option they have. In every recession, inflation declines as demand declines. Pretty simple. However, in this cycle, the problem has been that while demand has been falling, aspects of inflation have been stubbornly sticky.

It is now clear the goods inflation is rolling over and will continue to do so, which shouldn’t be surprising given commodities have largely softened, freight costs have come way down, etc. However, the service side of the economy, the bigger part of the economy, is still experiencing inflationary pressure. Why is that? Because services are generally labor intensive and therefore services are more directly influenced by wage inflation and that has only begun to decelerate and will ultimately prove to be the stickiest piece of the puzzle for the Fed.

The blue represents goods inflation and the orange line represents services inflation.

Our concern is that overcoming the goods side of the equation was the easy part. Bringing down wages will prove more difficult. We think we are going to see an extended period of very slow real growth, modest nominal growth and an inflation rate that continues to slide down from where it is now but persistently higher than where the Fed would like to see it. In other words, you are going to start to hear the dreaded “stagflation” term a lot in the coming months.

Talk of stagflation tends to elicit a visceral reaction. Everyone is reminded of the great stagflation of the late 1970’s and all the negative and difficult connotations of that time. We don’t see an environment that looks anything like the 1970’s. Maybe we should say “mild stagflation” or anything that sounds less dire. The fact is, we have been in a stagflationary environment all year already and we expect basically more of the same slowly softening trends. Employment will weaken and eventually we will see some negative non-farm payrolls before this is all over, but many service industries will remain tight and even as the unemployment rate ticks higher, the worker shortage in many industries and regions will persist. Mild stagflation with a tight labor market and persistent wage growth isn’t great for equities or fixed income markets but it is an economy where the Americans and especially the working class is in a much stronger position than the decay we remember in the late 1970’s.

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Tim Pierotti is WealthVest’s Chief Investment Strategist. 

Tim has over 25 years of experience in various aspects of the equities business. Prior to joining WealthVest, Mr. Pierotti spent seven years in Equity Research management roles at Deutsche Bank and most recently at BMO where he was a Managing Director and Head of US Product Management. Tim has 11 years of investment experience most notably as Head of Consumer Research and Portfolio Manager at The Galleon Group, a former NY based $8Bln Long/Short hedge fund. Tim is a graduate of Boston College and lives in Summit NJ.

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