SILVER LINING: Central Banks are getting on the inflation-fighting front-foot, with Fed’s cathartic 0.75% hike yesterday and Bank of England to hike for 5th straight time today. Amidst the many real parallels with the ‘stagflationary’ 1970’s, there are 2 big differences that give hope today. 1) Central bank credibility, implicit in market reactions to every Fed utterance and its forward guidance. 2) The resulting anchoring of longer term inflation expectations. These are a little over 2% in the US today versus inflation of 8.6%. This is ultimately positive for markets, implying a shorter, sharper cycle than the lost-decade of the 1970’s. Be invested, but defensive.
1970s: Saw toxic ‘stagflation’ combo of weak growth, high inflation and inflation expectations. Global inflation averaged 11% for the decade from 1973, 3x its prior level. This was worsened by two oil price shocks. It needed dramatic interest rate rises (see chart) to eventually control inflation, triggering three US recessions from 1969-1980, and several financial crises. As now, the period started with negative real interest rates, fiscal stimulus, and rising wage pressures.
MARKETS: History rhymes not repeats. The 1970’s performance playbook has only partially worked so far, with ‘hard assets’ commodities and housing doing similarly well, and bonds even more poorly. Large cap equities, and especially small caps, have done much worse. They’ve been able to pass through inflationary cost pressures, but lost out to plunging high valuations.
All data, figures & charts are valid as of 15/06/2022