When it comes to analyst projections about where the economy goes from here, “recession” seems to be the most popular conclusion.
An October Wall Street Journal survey of economists found that 63% of them expect a recession in 2023. A variety of individual “rock-star” economists – including S&P 500 Global Ratings chief economist Beth Ann Bovino and former Treasury Secretary Larry Summers – have publicly declared their expectations that recession is coming. And according to a Bloomberg Economics forecasting model, there’s a 100% chance of a recession striking sometime next year.
However, when you ask those on the front lines of asset management what they see in the near term, an increasing number of them expect the economy to tangle with recession’s more-obnoxious cousin: stagflation.
Stagflation is a rare beast, which is why we don’t see it very often. What makes it so rare is that its two principal ingredients are high inflation and low economic output – conditions that tend to exist in opposition to one another. Inflation typically is symptomatic of an economy running hot, and hot economies obviously are the opposite of sluggish economies.
However, there are times when the genesis of inflation is not an organically thriving economy. Sometimes, inflation can result from supply shocks and/or expansionary fiscal and monetary policy. In the case of the inflation we’re facing today, experts variously see spendthrift fiscal policy, ultra-easy monetary policy and supply shocks at its root.
Interest-rate hikes are the only real tool at the Federal Reserve’s disposal to “fix” inflation. The idea is that if you raise rates high enough, it will curb the consumer appetite in an economy that’s inflationary because of organic demand. However, when the underlying reasons for inflation include – for example – a grossly outsized money supply and supply shocks of one kind or another, rate hikes may not be as immediately and obviously effective.
Take this year, for example. Interest rates have been raised no fewer than six times in 2022, with the last four of those hikes in jumbo-sized increments of 75 basis points. Still, inflation remains just a little below its 40-year highs.
So, even as rate hikes work against economic output and bring us closer to recession, inflation may hang on for some time to come. This helps to explain the growing stagflation expectations on the part of the asset management community.
An economic environment characterized by the existence simultaneously of both high inflation and weak output pose can pose significant challenges to retirement savers. But that doesn’t mean those retirement savers have no way to push back against the impact of stagflation.
In fact, during what has been the most notable example of stagflation in modern American history up to now, one asset distinguished itself with a particularly robust performance. Notably, the chief investment strategist of the world’s largest hedge fund recently identified that same asset as her choice to hedge against the impact of the stagflation that she and others now say is in our near-term economic future.
We’re going to identify that asset a little later. But first, let’s see what all these asset managers are saying about our stagflation chances and why they might be saying it.
Each month, Bank of America (BoA) conducts a monthly survey of fund managers. The results of the inquiry are watched closely by the global financial and economic community. And according to BoA’s latest survey, there’s an overwhelming expectation that stagflation will define next year’s economic environment.
A big part of what makes the results so resonant is the comprehensiveness of the survey. 272 fund managers – who collectively oversee nearly $800 billion – were polled. Of that sample, a full 92% said they expect stagflation within the next year.
Another 7% said they’re looking for “stagnation,” which refers to a low-inflation/low-growth environment. Notably, none of the respondents said they’re anticipating a “goldilocks” environment, which refers to an ideal mix of low inflation and robust growth.
The BoA survey isn’t the only recent research that found money managers are planning for a stagflationary 2023. Bloomberg’s MLIV (Markets Live) Pulse Survey also concluded that stagflation is the consensus expectation of asset managers next year.
According to those results, 50% of professional investors said they’re planning for stagflation in 2023. Another 36% see a deflationary recession as the likeliest prospect. 7% of the survey respondents said they expect to see a “goldilocks” scenario, while another 7% anticipate an environment of high inflation and strong growth.
“Next year is still going to be difficult,” said Nicole Kornitzer of $6 billion Kornitzer Capital Management Inc., which oversees about $6 billion. “Definitely, stagflation is the outlook for now.”
That so many fund managers are convinced stagflation is lurking right around the corner suggests that the components of the normally unusual condition are very visible to them right now.
Let’s see what they might be looking at.
In order to anticipate stagflation, asset managers have to be seeing clear signs that we’re in store for both poor economic output and higher inflation next year.
That’s easy. The truth is we already have been experiencing sluggish output. Real GDP was outright negative in each of 2022’s first two quarters. And while a favorable net exports measure sparked GDP to a positive 2.6% reading in the third quarter, forecasters anticipate GDP will go negative again in the fourth quarter.
Fannie Mae economists expect that when the dust settles on 2022, full-year GDP growth for the year will be 0.0%. That brings us to next year. Fannie Mae’s projections for 2023 overtly tilt to the downside: negative 0.6%.
A number of other analysts and organizations see GDP growth either negative or tantamount to negative next year. The Conference Board, for example, expects to see zero-percent economic growth in 2023.
As for inflation, prices are expected to remain uncooperative into 2023 and beyond, so it seems clear the other essential stagflation component will be in place, as well.
Key inflation measures are expected to recede from the significantly high levels we’ve had to endure so far this year. However, economists – both public and private – believe inflation will remain well above target (2%) through at least 2023. The Philadelphia Federal Reserve’s Survey of Professional Forecasters (SPF) expects core CPI to hang in at 3.5% in 2023, while projections of headline CPI for 2023 from the world’s leading investment banks run as high as 5%. For his part, Johns Hopkins economist Steve Hanke – who has accurately predicted inflation’s path up to this point – expects CPI to be at 5% heading into 2024.
It seems, then, that stagflation’s most essential ingredients will be baked into next year’s economy. And putting an exclamation point on stagflation projections is the additional consensus projection that we’ll see higher unemployment in 2023. For example, the Philly Fed’s SPF expects unemployment to move up to 4.2% in 2023, while the Conference Board sees it moving as high as 5%.
Based on the projections of not only inflation and output but unemployment, as well, it makes sense why stagflation has become the consensus 2023 forecast of asset managers.
Bridgewater Associates is the world’s largest hedge fund. Bridgewater’s chief investment strategist, Rebecca Patterson, is another of the voices saying that stagflation will be the economy’s base case through at least the near term. That’s not all she’s been saying, however. Patterson also has been vocal in her opinion that one of the best ways to diminish the impact of stagflation is with gold.
As Patterson and her team started to consider the likelihood that stagflation could prevail for the foreseeable future, they researched which assets were the most beneficial in economic circumstances characterized by low growth and higher inflation. Going back 100 years in their examination, Bridgewater determined that gold has been a particularly “solid” asset (pun intended) throughout periods of stagflation.
It’s valuable information, to be sure. But even if we didn’t have it, we still would have the historical record of gold’s performance during what is perhaps the most infamous period of stagflation in American economic history.
From 1973 through 1982, inflation proved to be a tremendous challenge, rising to double digits on multiple occasions while never dropping much below 6%. The country fell into recession three separate times in those years. And monthly unemployment climbed as high as 11% and never dropped below 4.6%.
During that tumultuous stretch, gold strengthened considerably, appreciating nearly 600%. As a matter of fact, silver acquitted itself very nicely, as well, rising 435%.
Let me be clear: Gold may or may not be an appropriate choice for you as a way to try to hedge your savings against a potential stagflationary environment. Only you can decide that for yourself.
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