The economic headlines have changed for the worse over the last year. In 2021, record low interest rates, above-trend economic growth, record-high stock markets, and global economic recovery were making headlines. However, towards the end of 2021, some economists started talking about the possibility of stagflation.
Such warnings were dismissed as alarmist back then and even Twitter’s then CEO Jack Dorsey was ridiculed for forecasting hyperinflation. Fast forward to 2022 and stagflation looks like a real possibility. What happens in stagflation and will it happen in 2022?
What is stagflation?
To begin with, we should understand that stagflation is an economic nightmare. Stagflation is characterized by low growth and high inflation and is accompanied by rising unemployment. It might sound counterintuitive since generally strong economic growth leads to high inflation and vice versa. However, this is precisely what makes stagflation a nightmare.
What happens in stagflation
In stagflation, the demand in the economy tumbles, which pushes down economic growth. At the same time, prices for goods and services rise, which pushes up inflation. Add the high unemployment and we have a perfect storm for the economy.
Policymakers and central banks face tough choices in stagflation. While central banks raise rates to tame inflation, in stagflation they risk dampening the already weak economic growth. Conversely, if central banks cut rates to fuel economic growth and boost employment, they risk fueling the already high inflation.
Top economists warn of stagflation in 2022.
Allianz’s chief economic adviser Mohamed El-Erian sees stagflation as imminent in 2022. Bob Price, the co-CIO of Bridgewater Associates, the world’s largest hedge, has also warned of stagflation. The fears are shared by other fund managers. Bank of America’s global fund manager survey showed that over three-fourths of the respondents see “below-trend growth and above-trend inflation" as the most likely economic outcome over the next year.
The U.S. economy witnessed stagflation in the 1970s.
Talking of stagflation, it's hard to not talk about the 1970s when the U.S. economy witnessed severe stagflation. It was driven by the oil shock, which drove U.S. inflation to double digits and prompted the Fed to raise its policy rates to as high as 20 percent by 1980. Even the current stagflation talks revolve around a kind of oil shock that we are witnessing after Russia’s invasion of Ukraine.
Will there be stagflation in 2022?
There are quite a few signs that we are headed towards a recession in 2022. U.S. inflation is running at multi-year highs while economic growth has slowed down. Some of the recent earnings reports point to a further slump in the U.S. economy. While retail companies warned of slowing retail spending, Snap has raised concerns about digital ad spending.
Some of the pockets are also witnessing job losses, the mortgage industry for instance. Companies like Meta Platforms and Uber also going slow on hiring. A lot of companies, including Amazon, now find themselves overstaffed as the high growth rates of 2021 have fizzled away.
Overall, the U.S. job markets have been strong and the economy added 428,000 jobs in April, while the unemployment rate was 3.6 percent. The low unemployment rate and high household savings are cushions against a growth slowdown in the U.S. If inflation remains red hot, as it is currently, stagflation fears will only increase.
Here's how to invest during stagflation.
Stock markets invariably crash in stagflation. However, certain sectors can outperform in stagflation. If you're a debt investor, inflation-protected instruments like TIPS or I Bonds could be a good investment option.
As for stock markets, stocks of commodity companies, including oil and gas companies, can be a good bet. Incidentally, Warren Buffett has poured billions into energy companies. Chevron and Occidental Petroleum are among Berkshire Hathaway’s top 10 holdings now. Also, defensive stocks can outperform growth names in stagflation.
Gold could also outperform during stagflation as investors seek the stability of safe-haven assets. The precious metal outperformed during stagflation in the 1970s.