It's the Nation's Stag Party, and I'll Cry if I Want To
5/2/2005 7:53 AM ET
Folks who remember the economic malaise of the late 1970s and early 1980s should recall that the concept of "stagflation" is rather unsettling. It's the lovely combination of a continued rise in inflationary pressures, stagnant business activity, and growing unemployment. An inflation-full economic environment begets excessive buying activity on behalf of consumers, as Americans "stock up" on goods they expect to continue spiking in price. Demand is viewed as heavy, prices rise further, and a vicious cycle ensues.
Twenty-five years ago, efforts from then-President Jimmy Carter to combat this painful strain on America's economy were largely unsuccessful. Only the Federal Reserve, which raised interest rates and cut down on money printing, was able to halt inflation and out-of-control spending. This, in turn, plunged America into a period of recession until about 1982.
I hope our nation's financial leaders can learn from our clouded history and avoid such a chain of events from occurring. Over the past few weeks, I've noticed a lot of talk in the press about rising inflation, slowing growth, and the possibility for stagnation or stagflation. Since these articles have been hitting newsstands with some frequency, there is a general buzz among market-watchers that there is a level of fear in the marketplace that is "healthy" enough to generate a rally in the stock market.
While I agree that a "wall of worry" provides a foundation for a rally, I think many are mistakenly interpreting these matter-of-fact, or even complacent, articles as a sign of fear. One term I'm seeing a lot is the so-called "soft patch," a reference to current lousy economic numbers as being merely a temporary setback. Here's a flavor of what I've seen over the past couple of weeks when slowing growth, inflation, or both (stagflation) are discussed in the financial press.
4/27/05 The Wall Street Journal, "...but the likelihood of stagflation is remote."
4/25/05 BusinessWeek, "Despite the concerns, the smart money knows several bullish indicators are flashing"
4/25/05 Dow Jones Newswire, "But fears that growth is dead - or dormant - are premature"
4/23/05 Financial Times, "The short answer is that growth has hit a soft patch, and inflationary pressures are increasing, but talk of stagflation is needlessly alarmist."
4/23/05 USA Today, "A panel of 55 top economists expects comfortable expansion ahead, with moderate job growth and moderate inflation"
4/22/05 The Wall Street Journal, "Mind you, we are miles from what I would call real stagflation"
4/21/05 Dow Jones headline, "The Soft Match May Just Be Seasonal Noise"
4/21/05 Barron's Online, "This emotion-driven decline is an aberration"
4/21/05 New York Times, "...the economy could be experiencing 'stagflation lite'"
4/20/05 The Wall Street Journal, "The market's sudden fears of a dire economic slowdown, even a recession, strike me as irrational."
4/19/05 USA Today, "High oil prices are having some impact on the U.S. economy, but prices are still far from a level that could cause significant damage..."
4/18/05 The New York Times, "...we don't have a lot of evidence that things are terrible yet."
4/18/05 The New York Times, "The marker has sort of unjustified fears, and I think that will turn around"
4/18/05 Dow Jones Newswire, "It's premature to drastically mark down the prospects for economic growth"
4/14/05 The Wall Street Journal, "The economy looks to be in fairly good shape, and inflation appears to be well contained."
Now I'm not trying to be an alarmist, nor is my intent to send people spiraling into painful déjà vu about one of our economy's darkest hours. But I do think a little more trepidation and realistic acknowledgement of risk is warranted at this juncture. After all, during the past week, a prominent market strategist increased his allocation to stocks, while a mutual-fund manager proudly boasted that he decreased his cash position from 20 percent to three percent. Three percent? These are not actions born out of "fear."
Does this mean I am 100-percent certain stagflation or recession will emerge? Absolutely not. What I am suggesting is that the risk of an economy that greatly disappoints Wall Street has greatly increased. Furthermore, the complacency I have noted sets the equity market up for limited upside if stagflation does not emerge, because investors are already fairly confident that it won't happen and that the economy is only hitting a "soft patch." Conversely, the market is vulnerable to considerable downside in the event that signs of stagnation (or stagflation) rear their ugly heads, as all indications are that this would be a negative surprise. The following economic factors suggest that investors should be anything but complacent:
Poor employment numbers. March's nonfarm payrolls rose by 110,000, falling considerably short of analysts' consensus estimate for a 225,000 increase.
Weaker-than-expected retail numbers. In March, retail sales inched up 0.3 percent, disappointing Wall Street forecasts of a 0.8-percent rise.
Gross Domestic Product (GDP). The first-quarter 2005 GDP rose just 3.1 percent, the slimmest increase in two years. The number was a disappointment to economists, who held a consensus view of 3.6 percent.
Spread between two- and 10-year bonds has narrowed to a four-year low. Please refer to part four of this commentary for a discussion about the risks of narrowing bond yields.
25-year high in the Commodity Research Bureau (CRB) Index. Since February 2002, this index has rallied 66 percent. Chalk this up to the "some impact" that increased oil prices have been having, along with the rising costs of other lower-profile commodities.
The Producer Price Index (PPI) and the Consumer Price Index (CPI). Both of these inflationary barometers posted higher-than expected increases in recent weeks.
The Fed is raising rates! And, in fact, Alan and company are in a difficult situation, as growth indicators are coming in weaker than expected, while inflationary indicators are coming in higher than expected.
Oil remains higher than forcasts. This was true in '04 and continues to be true in '05.
Over the past few weeks, we've seen a number of basic materials stocks get clobbered despite positive earnings surprises.
With all of these factors on queue, it seems the economy and thus the stock market are at greater risk of disappointing investors than most will have you believe. The economy is just like the stock market in this way - high expectations set the stage for thundering disappointment, while realistic (or low) expectations pave the way for a pleasant surprise or two.
Bernie Schaeffer
schaeffersresearch.com |
