Making Sense of the Insane U.S. Economy
And now for the day’s alternative view.
When a major event roils the markets and the economy, like say the Russian invasion of Ukraine, there’s a tendency to lose sight of the bigger picture…to imagine that this event is the sole cause of all the pain in the markets and to think that once its impacts diminish, everything will be fine and dandy.
Except of course, the world is more complicated than that.
By which I mean that Russia is just the current focus. Beyond Russia/Ukraine lies a bigger issue with the U.S. economy.
Supposedly, the economy is booming. Big job numbers came out with the most recent January reading, and employers are still having problems locating workers. Housing prices have escalated to record levels. The price of a used car is at an unheard of $30,000. All of which has the Fed itching to raise interesting rates after years of keeping them bound to the floor.
But…
The Atlanta branch of the Federal Reserve offers its own hot take on the U.S. economy with something called GDPNow, which incorporates all the knowable data into a matrix that then spits out expectations for the upcoming economic reports.
As of the Feb. 17 release, the Atlanta Fed expects first quarter economic growth will register barely above 1%. Granted, that’s up from just under 1%. But, frankly, anything on either side one measly percent is nothing to get excited about.
It says the U.S. economy’s recent activities have largely been vapor.
Like that crazy 6.9% growth in Q4.
It turns out that once you dig inside those numbers from the final quarter of last year, 4.9 percentage points of that growth was due to companies adding inventory before prices ran up too much. But inventory changes are generally a zero-sum game since they end up running off.
Think of it as the run on toilet paper that happened in the early days of COVID. Some people bought a year’s worth of TP in one go. But that just means they won’t buy toilet paper for a year.
The net effect is that the “real” Q4 economy grew at a more logical 2%, not 6.9%.
And if the Atlanta Fed is right, then the economy is actually slowing. (Just so you know, the Atlanta Fed tends to be more accurate than most economists.)
So, what does all of this really mean, Jeffrey?
Well, it seems fairly clear that the Federal Reserve Open Market Committee (the wizards yanking on the string of interest rates) are eager to raise rates in March. Could be by 0.25%…though I won’t be surprised to see a 0.5% increase.
Yet, that increase is happening even as the real economy is weaker than the headlines.
And it’s happening as inflation is running at 40-year highs.
Put all those numbers and facts into the think-o-lator and what comes out is…
Stagflation.
I’ve mentioned stagflation a few times in the last year or so. That, I believe, is our destination as an economy: higher consumer prices (inflation) with wages and real economic growth that go nowhere (stagnation).
Stagflation is already popping up in Germany and China, two of the world’s premier economies.
The Russia/Ukraine situation threatens to exacerbate the problem with higher commodity prices amid the threat of possibly a recession from slowing global trade activity.
In America, jobs, though they’ve increased, are still well behind pre-COVID numbers. Moreover, the jobs we’re creating are increasingly low-wage, service-sector jobs that have zero hope of allowing workers to afford new houses and new cars…or even used cars!
That does not a strong economy make.
Our last real bout of stagflation was in the late 1960s and ’70s, and that was a nasty period for stocks. From the S&P 500’s 1968 high to its 1974 low, stocks fell 45%. Then again, back then, stock prices weren’t trading at A Clockwork Orange valuations—i.e., looney bin prices.
Today? Still looney bin, even after the recent decline.
The price-to-earnings ratio on the S&P is mid-20s, basically 2x normal valuations. We could see stocks trace a painful, slow grind lower as stagflation plays out.
Not all stocks, mind you. Some will fare well. Like…commodities.
Gold did well during the last bout of stagflation. Silver did even better. Raw commodity prices surged for industrial metals and food crops.
And farmland did well. U.S. Department of Agriculture data show that farmland gained about 14% per year even as stagflation rolled across the landscape. House prices, meanwhile, where a mixed bag at best—which is exactly what I would expect this time, given that the median home price of $375,000 is well beyond the means of most Americans. I can’t see already overheated housing markets racing higher when consumer purchasing power is waning.
In any case, that’s the movie plot I see taking shape.
Invest—or divest—accordingly.
The rest of 2022 is going to be a challenging year for the economy and the markets.
