The Stench Of Stagflation
Martin T. Sosnoff 06.19.08, 12:30 PM ET
The scariest, dirtiest word in economist lingo is "stagflation," and with zero growth and rising inflation, we've got it now.
For financial markets, it's the equivalent of Black Plague. When you see it coming, you run for home, lock your door and order a hundred pounds of sugar and potatoes, bake your own bread, cut out bottled water, and turn down your thermostat by five degrees in winter.
I remember my brother rolling up his Sunday Times into neat bundles to burn in his fireplace. He couldn't afford to stockpile much wood. In the Great Depression, my mother cut back hamburgers to the size of a silver dollar, adulterated with corn flakes. When I told this story to my 30-year-old son, Jason, he looked at me quizzically as if I were embroidering another Depression baby tale.
For guys in work boots and single moms holding down two jobs to make ends meet, life turns ever more miserable as the tightening vise of inflation bites into the flesh. You're already spending 15% of your income at the fuel pump. The pickup truck sits forlornly in your driveway. Going to the movies is a big-ticket item and you can't afford to eat in fast food restaurants more than a couple of times a week.
Ice water in jugs replaces beer cans in the fridge. You worry less about lost overtime and more about layoffs. General Motors (nyse: GM - news - people ) and Ford Motor (nyse: F - news - people ) are padlocking factories that make trucks and SUVs. Both automakers will operate in the red this year, and maybe longer, into 2009. Their foreign manufacturing complexes keep them alive.
Even the solidly middle-class will ease back on discretionary spending--fewer plane trips, shorter stays at resorts. Vegas is out of the question. There's decent cuisine in your neighborhood bistro. Why splurge?
There are, however, winners from the price perversions wrought by inflation on the economic landscape. The break-even time on solar panels is now reduced from eight years to less than five. A hybrid car makes more sense, too.
On the other side of the devalued coin, if you're an airline employee, even a pilot, you know what's coming: layoffs. Management is grounding hundreds of gas-guzzling 737s that are 15 to 20 years old. Fuel now devours 50 percent of costs, and most airlines hedged only a small percentage of usage. Most of them may have enough working capital to get them through only the next 12 months or so.
I know couples who stick together nowadays for the sake of the mortgage. During the Great Depression, getting a divorce was unthinkable--there was nowhere to go to. Husbands and wives fought continually. The dissonance spilled out into the hallways. This was pre-air-conditioned America. Everyone sweltered summers and complained about the landlord skimping on steam heat in the winter time. Landlords had a tough time collecting monthly rents. Consolidated Edison's (nyse: ED - news - people ) meter readers would bang on tenant doors. Everyone hid when the meter man entered their building.
The overwhelming sense back then was that the country had failed us. Sure, you could go on the relief rolls and maybe get $25 a week, but many families, ours among them, were too proud to accept a relief check, and so suffered silently.
I turned entrepreneurial. Yankee Stadium sat nearby; at the break of a baseball game, I would sell afternoon newspapers, ice cream and souvenirs. I made enough to pay for my music lessons, 25 cents a week for a half hour. At nine years old, I owned my own alto sax and a wooden clarinet. I bought them used, on time, and paid off my music teacher a buck a month.
Today, however, I have that same feeling that our country is failing us. No quarrel with the Federal Reserve Board; they executed flawlessly. My problem is with past presidents and the Congress, going back to the days of Jimmy Carter. We never put an energy policy in place. Can you hear that, Bill Richardson?
Nobody is coming up with more than patches. That goes for Congress and our presidential candidates. Sure, you can raise margin requirements on oil futures and other commodities. But Alan Greenspan wouldn't think of it, and he was right. You don't tamper with the liquidity of financial markets.
How shameful that we rely on King Abdullah to step up Saudi Arabia's oil production by 500,000 barrels a day. I doubt they can pump much more, and it's heavy oil--too expensive to refine profitably. We are going to see serious demand destruction with oil futures selling over $130 a barrel.
Meanwhile, food inflation is in the cards, too. I never looked at corn futures as a stock-market metric until this spring. Now, I scan them daily to track food inflation. With the Midwest farmlands plagued by torrential rains, corn futures spiked off the page to $7.50 a bushel, up from $6 just a few weeks ago. Meat prices ratchet up along with substitute cattle feeds like wheat and soybeans. Fertilizer producers press prices unmercifully. Why should they allow farmers to get too rich?
With corn futures one year out equally buoyant, the phosphate and potash operators adjust prices to keep farmers' gross margins constant rather then bulging. Comparable thematics prevails for iron ore, copper and steel, where higher costs for labor, energy and materials escalate and are passed along to users.
Against this generally rising level of the price of "stuff," the U.S. is entering a phase of rising unemployment as manufacturers, airlines, restaurant chains and retailers cut back. It's inconceivable to me that consumers will not contract discretionary spending, which has been a fatter share of income over the past five years than it has been historically.
Congress and our presidential candidates surely don't get it. They are advised mainly by conservative economists who fear and abhor deficit spending. But it's what we need now.
The country cries out for massive infrastructure projects, as much as $300 billion. Nobody in Congress has this number in mind. Obama's people talk about $60 billion--just peanuts. Extending unemployment benefits alleviates pain, but little else. Infrastructure spending--roads, bridges, schools, railroads--has a multiplier impact of at least 1.3 times.
It's easy for me to rationalize a stock market 10% lower, but I'm holding on to great tech houses with position on the board, like Google (nasdaq: GOOG - news - people ) and Apple (nasdaq: AAPL - news - people ). At the other end of the spectrum are beneficiaries of inflationary biases, actually the creators of inflation, like Potash Corp. of Saskatchewan (nyse: POT - news - people ), Mosaic (nyse: MOS - news - people ), and Transocean (nyse: RIG - news - people ).
Energy stocks, so far, have not participated in the most recent oil futures spike. Ironically, these firms are vulnerable to enormous cost inflation for oil-field goods and services. The group rests cheap, discounting $100 oil and nothing higher.
Until we see how much oil demand destruction takes hold, the stock market is chained to the commodities futures fireworks. If oil consumption drops 2 million barrels a day, about 2%, Abdullah's belated largesse becomes an empty gesture.
Let's hope I'm wrong on all this stagflation music and that Mr. Market is smarter than I am. Like Old Man River, "he mus' know sumpin', but don't say nuthin' … he jes' keeps on rollin' along."
Martin T. Sosnoff is chairman and founder of Atalanta/Sosnoff Capital, a private investment management company with over $9 billion in assets under management. Sosnoff has published two books about his experiences on Wall Street, Humble on Wall Street and Silent Investor, Silent Loser . He was a columnist for many years at Forbes magazine and for three years at the New York Post . He owns personally, and Atlanta Sosnoff Capital owns for clients, the following stocks cited in this commentary: Google, Apple, Potash and Mosaic. |
