- Martin Sosnoff
STAGFLATION: A Very Dirty Word
The ugliest word in financial mumbo jumbo is stagflation. Stands for little or no growth with inflation running north on the page. The New York Times past week ran a story on just such a forecast by the World Bank but with no editorial commentary on the World Bank’s forecasting record.
Lemme give you the World Bank’s cycle-to-cycle record. It’s dismal. First off, everyone missed the call on the worldwide recession of 1982. They underestimated staying power of the Group of Seven’s major economic reach led by Paul Volker, then our FRB chairman. Thousands of economists saw this happening but underestimated the resolve of our central banker.
What’s revealing is nobody gets economic forecasts right for more than a couple of quarters. Going back decades, it took just 3 quarters for GDP to move from 6% in mid-2000 to nearly zero by the opening quarter of 2001. Now, we are about to be buried in think pieces predicting doom and gloom for years to come.
Just like the enormous volatility of currencies, changes in interest rates normally are sizable and can be long lasting. Passive forecasts on interest rates normally are modest because they assume little change in the rate of inflation. The Blue-Chip consensus has missed its inflation forecast by over 1 percentage point, more often than not. This is a 33% variance.
The way to look at forecasts is to assume they are politically induced, adding to the noise level of the market and likely to prove inaccurate. The FRB’s current forecast of GDP growth around 2.5% holds little value added and is likely to prove wrong early on. Then, you come in with a new set of numbers going forward. If you’re wrong, forecast often.
When everyone is bearish on stocks and bonds, assume everyone has been buried by TheNew York Times and Wall Street Journal’s stories exuding doom and gloom, but with little or no critical commentary. Securities analysts use such published reports to develop their own forecasts on earnings power for the industries and companies followed. Usually, everyone gets it wrong at the same time, cycle-over-cycle. Look now at the major shortfalls in earnings projections for Amazon, Tesla, Netflix, Alphabet, Alibaba, even Home Depot and Walmart, of late.
Armchair investors should search for anomalies. The sun doesn’t rise and set on Wall Street. Black Monday (1987) proved the country was intact even though the Street’s circuit breakers had burned out. That day, I called J. Irwin Miller, headman at Cummins Engine in Columbus, Indiana. “Everyone’s sleeping soundly,” he responded. “Consider, our home prices have never budged.” That was enough for me to delve into the Street’s chaos. My trader at Solomon Brothers was afraid to even pick up his phone, fearing more sell orders.
Things are different today. The capacity utilization rate for industry is high and labor has more leverage on wages than I can remember going back to the mid-seventies. Then, Jimmy Hoffa demanded 7% wage increases for the auto workers. Ford and General Motors caved in, tout de suite.
You don’t make money in the stock market when inflation rises much above 3%. The FRB then gets busy boosting money market rates. The bond market sells off and price-earnings ratios get forced down for growth stocks, basic industrials for almost everything that walks.
Currently, supply disruptions in the energy sector press up oil quotes. Energy stocks, starting with Exxon Mobil, doubled over the past 12 months, making new highs nearly daily. Energy is now a major sector in the S&P 500 Index, around 20%, comparable with technology and more than the financials – banks, brokers and insurance houses.
The deep basic is the stock market hasn’t priced in an inflationary setting. The bear market in bonds is likely to continue. In previous cycles long-term Treasuries sold at a spread between investment grade corporates of at least 250 basis points lower. We aren’t anywhere near such a spread currently. I’m talking at least 250 basis points. We’ve got 10-year U.S. Treasuries at 3% and AAA corporates closer to a 100 basis point premium. Something has to give. Either rates decline for Treasuries or corporate bond yields move much higher, by at least 100 basis points.
This is bearish conjecture, because you never see a buoyant stock market when bond spreads between Treasuries and corporates start to widen. The history on spreads noted in the chart herein shows as much as a 500 basis point spike when recession fears overcome players in both stocks and Treasuries. The financial panic of 2008 – ‘09 shouldn’t recede too far from collective memory.