Podcast | Thought on the Market

Andrew Sheets: Stagflation Demystified

Morgan Stanley
Banking, Finance, Investment Strategies

Investor worries over growth and inflation have revived the term stagflation—but with growth indicators historically solid, is it an accurate description?

—– Transcript —–

Welcome to Thoughts on the Market. I’m Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I’ll be talking about trends across the global investment landscape and how we put those ideas together. It’s Friday, October 8th at 2:00 p.m. in London.

 

Near where I live in London, service stations are out of petrol – or to my fellow Americans, the gas stations are out of gas. In Europe, natural gas prices have roughly tripled in the last three months. Year-over-year, Consumer Price Inflation has risen 5.3% in the United States, 5.8% in Poland, 7.4% in Russia, and 9.7% in Brazil. It’s not hard to see why one term seems to come up again and again in our conversations with investors: stagflation.

 

Stagflation, broadly, is the idea that you get very weak growth, but also higher inflation together. Yet it’s equally hard to miss in these conversations that while this term is widely cited, it’s often ill defined. If stagflation means the 1970s, a time of wage price spirals and high unemployment, this clearly isn’t it. Unemployment is falling around the world, and inflation markets imply pressures will moderate over time, rather than spiral higher.

 

Market pricing is also very different. Over the last 100 years, the 1970s represented an all-time high in nominal interest rates and an all-time low in equity valuations. Today, it’s the opposite. We’re near a record low in yields and a record high in those valuations.

 

Instead, what if we say that stagflation is a period where inflation expectations are rising, and growth is slowing? That’s an easier, broader definition to apply, but even that hasn’t really been happening.

 

In the U.S., market expectations for inflation are roughly where they were in early June. U.S. economic data remains solid. The economic data is a little bit more mixed in Europe, but even here, growth indicators generally remain historically strong.

 

So this clearly isn’t a simple story, but we do think there are three takeaways for investors.

 

First, recall that stagflation was also a very hot market topic in 2004/2005. Growth and markets had bounced back sharply in 2003, but by mid 2004, the rate of change on that growth had started to slow. And then energy prices rose.

 

By spring 2005, the market started to worry that it could be the worst of both worlds. In April of that year, U.S. consumer price inflation hit 3.5% while measures of growth stalled. Stagflation graced the cover of the Economist magazine and the editorial pages in the New York Times. Equity valuations fell throughout 2004/2005 even as earnings rose, consistent with the current forecast that my colleague Michael Wilson and our U.S. Equity Strategy team.

 

The second important point is that inflation is already showing up and impacting monetary policy. In just the last three weeks, central banks have increased interest rates by +25bp in New Zealand, +25bp in Russia, +50bp and Peru, +50bp in Poland, +75bp in the Czech Republic and +100bp in Brazil. That’s a lot of activity. And all of this is keeping my colleagues busy and also creating opportunity in these markets.

 

Third, while stagflation means different things to different people, past periods of rising inflation and slowing growth have often had one thing in common: higher energy prices. As such, we think some of the best cross-asset hedges for stagflation lie in the energy space.

 

The market is very focused on stagflation; it just hasn’t quite decided what that term really means. The 1970s are a long way away from our expectations or market pricing. Scenarios of slower growth and rising inflation clash with our economic forecasts of, well, the opposite. And recent moves in inflation expectations and other growth indicators don’t fit this story as nicely as one would otherwise think.

 

Instead, we think investors should focus on three things: 2005 is an interesting and rather recent example of a stagflation scare after a mid-cycle transition. Inflation is impacting central banks, creating movement and opportunity. And finally, the energy sector provides a potentially useful hedge against scenarios where the current disruption is more persistent. Now, with that out of the way, I’m off to find some petrol.

 

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We’d love to hear from you.

Recommend a podcast...

More by

Podcast

November 24, 2021

Morgan Stanley

The Build Back Better Act took a key step towards becoming law last week, signaling implications for fiscal policy and taxation as the bill heads to the Senate.—– Transcript…

Podcast

November 23, 2021

Morgan Stanley

Our 500th episode! From all of us at Morgan Stanley, thanks to our listeners for all your support!An overview of our expectations for the year ahead across inflation, policy,…

Podcast

November 22, 2021

Morgan Stanley

With the release of our outlook for the coming year comes a cycle of feedback and debates from clients and investors. We look at those discussions around equity markets,…

Podcast

November 19, 2021

Morgan Stanley

Andrew Sheets continues his discussion with Chief Global Economist Seth Carpenter on Morgan Stanley’s more optimistic economic outlook for 2022, what’s misunderstood and where it could be wrong.—– Transcript…

Podcast

November 18, 2021

Morgan Stanley

Andrew Sheets speaks with Chief Global Economist Seth Carpenter on Morgan Stanley’s more optimistic economic outlook for 2022 and how consumer spending, labor, and inflation contribute to that story.—–…

Podcast

November 17, 2021

Morgan Stanley

This week’s meeting between President Biden and President Xi was not a return to an earlier phase of relations between their two countries. Instead, it suggested the normalization of…

Podcast

November 17, 2021

Morgan Stanley

The housing market has seen record home price growth this year. But who does this boom benefit and who gets left behind?—– Transcript —–Jim Egan Welcome to Thoughts on…

Podcast

November 15, 2021

Morgan Stanley

Coming out of a year marked by greater uncertainty and volatility, 2022 is poised to be a year which favors single stock investing over a focus on style and…

Podcast

November 12, 2021

Morgan Stanley

Over the last decade, bonds have been a source of stability. But, with surprising moves this past month, they’ve now become a risk-management challenge that stands out amongst other…

Podcast

November 11, 2021

Morgan Stanley

Coming out of last week’s FOMC meeting, the Fed’s wants are becoming clearer but the implications into 2022 for asset prices, interest rates and exchange rates remain to be…

Podcast

November 11, 2021

Morgan Stanley

The bipartisan infrastructure bill has passed, and while investors will see some short term impacts, the bigger question is how long will it take for markets to see a…

Podcast

November 9, 2021

Morgan Stanley

Third quarter earnings are heading into the home stretch in Europe and the UK, but while a solid number of companies have beat earnings estimates, market reaction has been…

Podcast

November 8, 2021

Morgan Stanley

As we head towards year end, stock and bond markets appear to be sending mixed signals for the year ahead. For investors, the truth could lie somewhere in the…

Podcast

November 5, 2021

Morgan Stanley

Global moves in elections, COVID restrictions and energy prices are having ripple effects across markets. How should investors think about these dynamics for Asia and EM equities?—– Transcript —–Welcome…

Podcast

November 4, 2021

Morgan Stanley

Central bank support has been a key driver of market strength since last year. So how will markets react during the months-long tapering process?—– Transcript —–Welcome to Thoughts on…

Podcast

November 4, 2021

Morgan Stanley

Inflation rates, commodity prices and central bank policy are tied together through self-referential loops. With today’s FOMC meeting, it is worth a closer look at these meta dynamics.—– Transcript…

Podcast

November 2, 2021

Morgan Stanley

‘Build Back Better’ has gained support from all corners of the Democratic Party, but questions remain over how the framework is paid for. For investors, a look at short…

Podcast

November 1, 2021

Morgan Stanley

Original Release on October 11th, 2021: As the weather chills and we head towards the end of the mid-cycle transition, the S&P 500 continues to avoid a correction. How…