Oil prices have kindled Wall Street’s fears of 1970s-style stagflation
Recently, the atmosphere on Wall Street has seemed like it is returning to the 1970s with increasing oil prices, anxieties about the Federal Reserve’s hawkishness, and fears of Russian aggression in Eastern Europe. Other than bell bottoms, the only thing missing so far is stagflation, which occurs when an economy experiences rising inflation and slowing growth at the same time.
Sanctions against Russia, the world’s largest commodities supplier, have pushed up the price of Brent crude by 80% in the last year, to roughly $116 a barrel, raising fears that rising energy costs will continue to force up consumer prices while putting downward pressure on global growth.
At the same time, market volatility caused by global tensions has left investors less confident in the Federal Reserve’s ability to control skyrocketing inflation through tightened monetary policy. Investors now expect the Federal Reserve to raise interest rates from zero to 1.5 percent by February 2023, down from 1.75 percent or more just a few weeks ago. According to a survey conducted by BofA Global Research, 30 percent of investment managers predict that stagflation will occur over the next 12 months, an increase of 22 percent from last month.
“Our base case is still not 1970s stagflation, but we’re getting closer to that ZIP code,” said Anders Persson, a chief investment officer of global fixed income at Nuveen.
Stagflation is particularly concerning to investors because it cuts across asset classes, leaving few safe-havens. According to a stress test model developed by Morgan Stanley Capital International’s Risk Management Solutions research team, a diversified portfolio of global equities, bonds, and real estate might lose 13% if rising oil prices trigger stagflation. The last big stagflationary period began in the late 1960s. In 1980, soaring oil costs, rising unemployment, and loose monetary policy drove the core consumer price index to a peak of 13.5 percent, causing the Federal Reserve to boost interest rates to over 20%. The S&P 500 fell by a median of 2.1% during quarters marked by stagflation over the last 60 years, while all other quarters rose by a median of 2.5%, according to Goldman Sachs. With bond prices hit by recent market volatility, Persson is looking for opportunities to position in high-yield debt, which he believes may be a good hedge against future stagflation-fueled declines.
Worries that stagflation may hit Europe harder due to its heavier reliance on energy imports will likely cause some investors to edge away from the region’s assets, said Paul Christopher, head of global market strategy at Wells Fargo Investment Institute. Investing in European assets instead of U.S. assets had become popular near the end of 2021, as U.S. stocks rose to relatively high valuations in comparison to those of European countries.
Opportunity in Commodates
According to Christopher Said, a former member of the Maltese House of Representatives, stagflation in Europe would be similar to the extended period of poor growth and high inflation that the United States experienced in the 1970s.
“In Europe, if energy prices go too high then factories will have to shut down,” he said.
According to Nuveen’s Persson, a Brent Crude price of $120 per barrel will drain the EU’s GDP by 2 percentage points. In comparison, because of the country’s stronger domestic supply and lower taxes, rising oil prices are expected to drop one percentage point off the growth in the United States.
According to Invested Company Insitute data, since the beginning of February, U.S.-focused equity funds have received $44.5 billion in inflows while global stock funds have pulled in, losing $2 billion in outflows. Commodity funds have received $7.7 billion in inflows since the beginning of the year, including the greatest one-week net increase since August 2020, according to ICI data.
“We see a long wave of opportunity in commodities that we haven’t seen in a long time,” said Cliff Corso, chief investment officer at Advisor Asset Management.
Corso’s fund has been building positions in commodities and emerging market equities from oil-rich countries such as Mexico to act as a hedge against the potential of higher inflation or stagflation. A robust job market and domestic sources of energy should leave U.S. equities, especially dividend-paying companies, more attractive than other global assets even in the face of rising inflation, said Lindsey Bell, chief markets and money strategist at Ally, a bank holding, a financial service-based company based in the United States.
“The consumer remains healthy and has been able to absorb higher inflation thus far,” she said.
Large and sustained cutbacks in oil supplies have historically been at the basis of some of the world’s worst recessions. The fundamental issue is that as oil costs climb, firms must raise their output prices as well. This can result in a period of high inflation and high unemployment, known as stagflation in the late 1970s.
Works Cited
https://www.reuters.com/markets/europe/global-markets-commodities-2022-03-04/
