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What I Care About This Week | 2022 Mar 7

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by Franklin J. Parker, CFA | for ongoing updates through the week, you can follow me on Twitter

The Summary

The Details

Stagflation is again a buzzword.

First, what is stagflation? We can think of the interplay between economic growth and inflation as occupying four basic quadrants, as the graphic shows. In a normal expansion, inflation is low and growth is high. Inevitably, a recession follows and that tends to see low inflation and negative economic growth. As an economy recovers, it can enter into an “inflationary boom” which is where demand outstrips supply and prices rise along with the general economy. One could make the argument that this is what we saw through 2021.

However, inflation has taken on a life of its own, and it has begun to put downward pressure on economic growth. Low growth and high inflation is called stagflation.

For many reasons, stagflation is a serious problem. For one, it hurts the poorest the most. As prices rise faster than wages, and economic growth suppresses hiring, lower-wage workers are saddled with ever-increasing costs and ever-decreasing economic opportunities.

Also of concern is the lack of tools the Fed carries to deal with this environment. To combat the stagflation of the late 1970s, the Fed took interest rates into the low 20%s. At that time, however, US government debt was about 40% of GDP. Today, government debt is around 134% of GDP. Taking interest rates just to 4% would put considerable pressure on the federal budget.

The cause of stagflation is also of concern: supply chain troubles and war are not problems easily solved by policymakers.

Exactly how all of this gets ironed out is most anyone’s guess. I expect it will be some combination of higher rates and “just hold on until it gets better.” For investors, this creates some headwinds, and, as I have repeated many times, adaptability and nimbleness will be key in this environment.

Chart of the Week

The past few months has seen a divergence between the economic outlook of business leaders and the outlook of consumers. The Business Roundtable’s CEO confidence index is hitting all-time highs while consumer confidence has been on a steady decline since mid-2021. Divergences like this are rare, and it may indicate the unique challenges facing US consumers and the opportunity seen by their business counterparts.

I follow CEO confidence more closely than consumer confidence since the latter is much more volatile. CEO confidence is also a pretty good indicator of slowing economic growth. I get more concerned when I see CEO confidence flagging. In short, this is a mixed economic signal, but I would err on the side of optimism rather than pessimism.

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