Monthly Market Commentary

Stagflation – Should We be Worried?

Philip Blancato, Chief Market Strategist, Advisor Group

What is Stagflation and Why Should I Care?

Stagflation is defined by stagnant economic growth and elevated inflation. A stagflationary environment is particularly problematic for investors, harming both equities and fixed income. The combination of higher inflation and lower growth can erode profit margins, especially for companies that are unable to pass on higher costs to customers, causing corresponding weak equity market performance. For fixed income investors, inflation reduces the real spending power of coupon payments and can lead to negative real returns on bonds. 1

The prospect of stagflation’s return strikes fear into policymakers because there are few monetary tools to combat it. Raising interest rates may help reduce inflation, but the increased borrowing costs that result from this would further depress growth. Alternatively, keeping monetary policies loose, could push prices higher and amplify inflation. 2

Is Stagflation a Significant Risk at Present?

From the definitional sense, one may argue that we are currently experiencing stagflation as we saw negative GDP growth in the first quarter, while inflation is hovering near its highest levels in 40 years. However, we would contend that when digging deeper into the data, stagflation does not appear to be something you should be worried about. Here’s why:

1. Stagflation is typically accompanied by faltering demand. In the Q1 GDP reading, personal consumption and business investment grew at a +3.1% and +9.2% annual pace, respectively. 3 As the largest driver of the U.S. economy, an acceleration in consumer spending provides reason for optimism that the underlying momentum in the economy remains positive. Similarly, ramped up business investment shows companies are confident in continued consumer demand, which should lead to economic growth.
2. Stagflation is also accompanied by rising unemployment. Employers have added more than 400,000 jobs for 12 straight months, and the unemployment rate is near a half-century low. Businesses are advertising so many jobs, that there are now roughly two openings, on average, for every unemployed American.4
3. Stagflation is mainly caused by supply chain disruptions leading to higher prices. The New York Federal Reserve’s Global Supply Chain Pressure Index (GSCPI) increased for the first time since December 2021, however, this was mostly due to longer delivery times in China and the Euro Area, driven by lockdowns and the Russia-Ukraine conflict. 5 While we acknowledge that heightened geopolitical tensions could continue to stoke supply chain pressures in the near term, most of the components of the GSCPI declined in April, which is a positive sign that pressures stemming from COVID 19-related lockdown measures have mostly abated domestically.

Final Take:

Supply is still constrained, but demand, particularly labor demand, is likely to remain firm. Although investors are now focused on rate rises and higher inflation, the reality is that the consumer is still spending and, therefore, we still expect a continued global economic recovery. Again, if at times you see threats of stagflation appear in the headlines it is important to remember that consumer balance sheets are strong, following the savings accumulated during pandemic lockdowns. At the same time, business profits, while increasing at a slower pace than in 2021, are still growing and have already surpassed pre-pandemic levels. In this environment we continue to remain constructive on equites and are placing a premium on dividend paying value portions of the equity market. In the fixed income space, we remain shorter duration with an emphasis on floating rate securities. A steady dividend and coupon stream not only provides a hedge against inflation, but also allows you to get paid while waiting out potential market volatility.

Economic Definitions

GDP: Gross domestic product (GDP) measures the final market value of all goods and services produced within a country. It is the most frequently used indicator of economic activity. The GDP by expenditure approach measures total final expenditures (at purchasers’ prices), including exports less imports. This concept is adjusted for inflation.

Global Supply Chain Pressure Index (GSCPI): The GSCPI integrates a number of commonly used metrics with the aim of providing a comprehensive summary of potential supply chain disruptions. Global transportation costs are measured by employing data from the Baltic Dry Index (BDI) and the Harpex index, as well as airfreight cost indices from the U.S. Bureau of Labor Statistics. The GSCPI also uses several supply chain-related components from Purchasing Managers’ Index (PMI) surveys, focusing on manufacturing firms across seven interconnected economies: China, the euro area, Japan, South Korea, Taiwan, the United Kingdom, and the United States.

Disclosures:

Index performance does not reflect the deduction of any fees and expenses, and if deducted, performance would be reduced. Indexes are unmanaged and investors are not able to invest directly into any index. Past performance cannot guarantee future results.

Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect again loss. In general, the bond market is volatile; bond prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed-income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Vehicles that invest in lower-rated debt securities (commonly referred to as junk bonds or high-yield bonds) involve additional risks because of the lower credit quality of the securities in the portfolio. International investing involves special risks not present with U.S. investments due to factors such as increased volatility, currency fluctuation, and differences in auditing and other financial standards. These risks can be accentuated in emerging markets.

The statements provided herein are based solely on the opinions of the Advisor Group Research Team and are being provided for general information purposes only. Neither the information nor any opinion expressed constitutes an offer or a solicitation to buy or sell any securities or other financial instruments. Any opinions provided herein should not be relied upon for investment decisions and may differ from those of other departments or divisions of Advisor Group or its affiliates.

Certain information may be based on information received from sources the Advisor Group Research Team considers reliable; however, the accuracy and completeness of such information cannot be guaranteed. Certain statements contained herein may constitute “projections,” “forecasts” and other “forward-looking statements” which do not reflect actual results and are based primarily upon applying retroactively a hypothetical set of assumptions to certain historical financial information. Any opinions, projections, forecasts, and forward-looking statements presented herein reflect the judgment of the Advisor Group Research Team only as of the date of this document and are subject to change without notice. Advisor Group has no obligation to provide updates or changes to these opinions, projections, forecasts, and forward-looking statements. Advisor Group is not soliciting or recommending any action based on any information in this document.

Securities and investment advisory services are offered through the firms: FSC Securities Corporation, Royal Alliance Associates, Inc., SagePoint Financial, Inc., Triad Advisors, LLC, and Woodbury Financial Services, Inc., broker-dealers, registered investment advisers, and members of FINRA and SIPC. Securities are offered through Securities America, Inc., a broker-dealer and member of FINRA and SIPC. Advisory services are offered through Arbor Point Advisors, LLC, Ladenburg Thalmann Asset Management, Inc., Securities America Advisors, Inc., and Triad Hybrid Solutions, LLC, registered investment advisers. Advisory programs offered by FSC Securities Corporation, Royal Alliance Associates, Inc., SagePoint Financial, Inc., and Woodbury Financial Services, Inc., are sponsored by VISION2020 Wealth Management Corp., and affiliated registered investment adviser. Advisor Group, Inc. is an affiliate of these firms. 4772760

1 https://www.ubs.com/global/en/wealth-management/our-approach/marketnews/article.1562563.html
2 https://www.ft.com/content/d490ef4e-3187-471e-84ff-9c065871a1a5
3 Bloomberg as of 5/26/2022
4 https://www.washingtonpost.com/business/us-economy-shrank-by-15percent-in-q1-but-consumers-kept-spending/2022/05/26/b0638e9c-dcf0-11ec-bc35-a91d0a94923b_story.html
5 https://www.newyorkfed.org/research/policy/gscpi#/interactive

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