Does US have what it takes to go into 1970s like Stagflation?

Will US go in 1970s kind of Stagflation- Next 2 quarters economic indicators are very important…

(Please e-mail me if you are not able to see the charts)

US economy faced with Stagflation in 1970s. The situation was extremely acute in 1973-1975 when Dow Jones fell from 1020 to 608 in 2 years. In a simple term, Stagflation is a macroeconomic term used to describe period of high inflation combined with slow economic growth (or recession) and rising unemployment rate.

Equity market falls due to double edged sword (economic slowdown and inflation). Bond market does not do well as the real interest rate is often negative. Commodity market does well as it gives good hedge against inflation and beneficiary of outflow of fund from Equity and Bond asset classes.

GDP (White) growth and DJIA (Orange) in 1970s:


DJIA (Orange) and CPI (White) in 1970s:


Unemployment (White) and DJIA (Orange) in 1970s: The rising inflation and falling GDP took a toll on the unemployment with a lag.


Inflation (White) and GDP growth (Orange) (1972-1975): While GDP growth was going down, inflation was picking up


Unemployment (White) and Inflation (Orange) (1970-75): While inflation was rising from Mid 1972, unemployment also started rising one year after. Unemployment follows rise in inflation during slowdown.


Current Scenario 2008:

GDP growth started falling down. For 2008, economists are expecting a GDP growth of a mere 0.3-0.4% which was revised down from earlier expected 0.8% a month ago. Though there isn’t any expectation of negative growth but the downward revision in 1 month is scary.

GDP Growth (White) and DJIA (Orange):


Inflation (Orange) and Unemployment (White): While unemployment remains at the same level (however 50bps higher than 4.4% bottom in late 2006), inflation has moved up. And as we have seen in 1970s, unemployment lags behind the GDP growth (decline) and rising inflation. Hence, unemployment figure is to be closely watched which will strengthen the current stagflation case.


Unemployment (White) and DJIA (Orange) (2003-2007): While unemployment was declining during the period, DJIA rose then. However the of late, DJIA is falling and unemployment is rising.


Inflation (White) and DJIA (Orange): CPI which bottomed out by late 2006 has started going up. Food, commodity (incl fuel) are majorly responsible for this. China which was earlier world deflator, has started exporting its inflation which is at 11 year high of 8-8.5%. The inflation expectation in China is scary at the moment.

20year CPI expectation in the US has also moved up and people are expecting a higher inflation regime.



Crude (White) and DJIA (Orange): Crude is one of the major factors driving CPI (CPI includes Fuel and Food inflation). Crude which was moving ahead in 2004-2007 period was because of higher growth demand but now more because of inflation hedge tool and underinvestment.


Gold (White) and DJIA (Orange): Gold is a classic inflation and uncertainty hedge. It gives no income, however we feel happy if we have it (intangible benefit!!!)


Point to Ponder:

Gold/DJIA at 12 (12000/1000) is now at lower end of the green range (Stock low Gold high scenario).

What lies ahead? Would we see an aberration again as in the past; or will Gold go down/ Dow go up.



Conclusion:

I would not say that we are again in 70s kind of Stagflation, but the recent economic trend is a way towards that. GDP is off from 4% to 0.3%, inflation is high at 4.3% from bottom of 1.4% during the same time. Unemployment is on the rise, though not alarming. Commodity prices are going of the roof. In real negative bond yield scenario (inflation is higher than nominal interest rate) investors would not prefer bonds. Equity is already the most hated word now.

Does US have what it takes to go into 1970s like Stagflation? Keep an open eye on economic numbers…