The risk of stagflation and what we can do to prepare

Howdy,

Stagflation is a state of the economy characterized by high inflation, anemic economic growth, or even economic stagnation and high unemployment.

Normally, this economic phase is an anomaly since economic stagnation and high unemployment are accompanied by high inflation. Normally, if consumption and the number of employees in the economy decrease, then the prices of goods and services should not increase due to a lack of demand. However, this is exactly what happens in stagflation.

The last time we had a period (or more successive periods) of stagflation was in the years 1973–1982 (approximately) in the USA, a period characterized by high inflation rates, even over 10% per dollar, periods of economic downturn and quite high unemployment (between 5% and 10%).

To counteract high inflation, interest rates have been raised to 20%. Can you imagine a 20% dollar interest rate?

Also in the ’70s, the stock market had a very bad period in 1973–1974, when it lost about 50% in two years and then came back, but at a slower pace, taking 7 years to reach to the old highs of 1973.

Normally, the stock market can’t compete with government bonds that pay 15–20% interest per year, so we can only imagine why the US stock market suffered so much during the stagflation period of the 1970s.

Are we heading for stagflation?

At the moment we have inflation in the dollar of almost 8% and the euro of almost 6%. Official forecasts say that inflation will rise for a while until it reaches a peak, and will begin to decline in the second half of 2022, but will continue to remain relatively high for several years, above “ideal” inflation. of 2%, which would be de Droit.

At the same time, we are coming after the year 2021 in which we had a solid growth of the economy both in the USA (+ 5.7%) and in the Eurozone (+ 5.3%), but we are already starting to feel a slowdown from quarter to quarter of the growth rate, following that, according to the official estimates, to return starting with this year to temperate economic growths of 2–3%.

Fortunately, we are doing well on the unemployment side. In the US, for example, we have a reported unemployment rate of less than 4% in February 2022. There is even talk of a labor crisis in many developed countries.

Also, the EDF interest rate rose in March to 0.25% -0.5% !!!!! That is, we have 8% inflation in the dollar, the Fed’s interest rate is 0.5%, and analysts’ estimates say we will reach somewhere around 2% by the end of 2023.

The Fed is very careful not to affect growth through high-interest rates, but at the same time, it is set to do something (interest rate hikes) to counter inflation.

The Fed has a choice between counteracting inflation and curbing the economy. So far it is clear that it has favored the economy, considering that the negative effects of inflation are smaller than a weak economy and high unemployment.

The Fed may also be reluctant to raise interest rates on substantial debt owed by states (including the United States, which has a 137% to GDP ratio). These debts are interest-bearing and are constantly rolled over by new government bonds issued. If these new government securities were issued at much higher interest rates, then the state budgets would receive a substantial blow.

Thee interest rate is not the same as what happened in the 1970s. Thus, you may be wondering, how much can the stock market decrease, in case of correction, if the institutional investor shaves alternative government securities with insignificant interest rates?

I think that any more substantial stock correction should be an opportunity for large investors, given that the alternative would be to park money in government securities with 2% (in 8% inflation conditions).

What to do?

Well, as we saw above, the current situation is not very similar to that of the 1970s. Or, at least, there are still substantial differences from that period, with much lower interest rates and much lower unemployment.

On the other hand, speaking of consumption, the world population still has substantial savings accumulated in the two years of the pandemic, and now… with all the inflation… we see that people are very eager to consume, travel, to do everything they could not does in the last 2 years.

Tourism industry estimates are very optimistic this year. Thus, consumption could boost the economy and make it more resilient to future interest rate hikes.

Inflationary periods normally favor commodities and commodity-producing companies, especially energy, mining, and agriculture.

Also, if we have a period similar to the ’70s, we could see a good performance of gold. However, I do not expect to repeat what happened in the 70s with gold. Then we had a parabolic increase in gold of over 20X in 10 years, from $ 42 an ounce in 1971 to $ 850 an ounce in 1981. Then there were political factors that massively influenced the price of gold by detaching the dollar from the standard. gold.

Finally, we can conclude that the definite threat that we, the investors, have is also inflation, rather than stagflation.

All signs indicate high inflationary pressure that will persist for a while:

• Expensive raw materials;
• Supply chain issues;
• The war in Ukraine;
• Large deficits that are likely to continue to rise as states increase defense budgets;
• Substantial savings of the population that could not consume certain services during the pandemic and will now want to “recover”;
• Maybe even a labor shortage in some sectors;
• The large amount of money introduced into the economy through incentives and QE.

All this shows that the inflationary pressure is high and will probably continue for some time.

So what do we ordinary people have to do?

What we can’t do is be certain: let’s guess the future. There are so many variables and unforeseen events that, realistically, even great financial analysts cannot accurately estimate what will happen in the economy in the coming years.

All the less we, ordinary people.

However, we can do so much to prepare and have a good time, even to take advantage of whatever comes in the future:

1. First of all, we should put our finances in order: to use a budget, optimize our expenses, diversify our savings on important currencies (EURO and USD in particular);
2. Let’s increase our income and create additional sources of income. It is the best protection against inflation;
3. Let’s invest in stocks constantly, month by month. Given that everything that means a fixed income and low-risk instrument (deposits, government securities, quality corporate bonds) will surely lead to losses in real terms in the future and real estate in Romania… well, maybe we should not overexpose real estate in Romania at this time, as long as the geopolitical situation is so tense… then equity investments are the only viable alternative;
4. Let’s keep some cash/deposits for possible future corrections. We assume some loss of purchasing power through inflation to have ammunition in case of corrections, as were the recent ones;
5. And we make the most important investment we can make: in our education. It is the only investment that helps you to complete the first 4 points.

Good luck!