There’s little disputing the fact that retirement savers are living through a most confounding and hard-to-navigate economic environment.
Inflation has been well above the Federal Reserve’s 2% average target for nearly a year and a half. Interest rates have been rising steadily since March. As they do, resulting volatility has wiped between $9 trillion and $10 trillion in wealth from U.S. households so far this year.
The full-throttle rate-tightening cycle we’re in now suggests inflation should be relenting, but so far that’s not happened. It’s hard to tell if rate hikes are having any impact at all on inflation. While a 10.6% drop in gas prices last month helped lower the headline consumer price index (CPI) to 8.3%, core inflation actually accelerated in August.
As far as growth is concerned, there’s no shortage of mixed messages. Economic output was negative in the first two quarters of 2022, which meets the technical standard for recession. And based on the way that the Atlanta Fed’s real-time tracker of GDP is trending, we could be looking at a third straight quarter of negative GDP. On the other hand, official unemployment suggests a tight labor market and consumer spending remains resilient. So are we in a recession, sort of in a recession, not yet in a recession, or what?
Some professional observers have decided it’s unnecessary to overcomplicate the assessment of how things stand. In their view, official determinations of recession while prices remain elevated aren’t required to decide its stagflation we now are facing. High-profile economist Mohamed El-Erian made his own declaration of stagflation back in June, referring to it as the “baseline” for where things are at.
El-Erian is not the only figure of note who sees stagflation in our midst. Rebecca Patterson does, as well. Patterson is the chief investment strategist at world’s-largest-hedge-fund Bridgewater Associates, which presently has assets under management in the neighborhood of $150 billion.
In a comprehensive interview with Pensions & Investments, Patterson made the case for why she – like El-Erian – sees stagflation as the prevailing economic condition, as well as why she believes it could persist for some time to come.
But that’s not all. Patterson also took the opportunity to mention that gold has been one of the best-performing assets, historically, during periods of stagflation.
Considering she’s the chief investment strategist of the world’s largest hedge fund, I think Patterson has a relatively uncomplicated way of “reading” the economic landscape and deciding how to proceed. In this case, she sees chronic higher inflation and stumbling growth, and concludes we’re in the midst of stagflation. Next, she and her colleagues determine which assets have performed the best in stagflationary environments and proceed based on that information.
It’s a straightforward approach that I think sets a good example for the rest of us – and one at which we’re going to take a closer look.
So let’s get started.
In order for stagflation to exist, the inflation that the Fed is trying to chase away must, by definition, remain resistant to those efforts. Patterson sees that resistance lingering for some time, and doing so largely because of what she thinks will be a particular “stickiness” to rent- and housing-related inflation:
We’ve already seen housing activity slow as mortgage rates have gone up and as houses have gotten less affordable. But what that does is it pushes households out and they rent instead of buy. Rents reset more gradually. And so rent inflation tends to last longer; it’s kind of the sticky tail of the housing cycle, if you will.
Sure enough, the shelter index – which makes up roughly one-third of headline CPI and 40% of core CPI – is accelerating, as the most recent government inflation report reveals. On a monthly basis, the cost of shelter rose 0.7% in August compared to 0.5% in July. And on a year-over-year basis, the shelter index jumped 6.2% in August after rising 5.7% the month before.
As for the growth side of the stagflation “equation,” I thought it interesting that Patterson did not reference the fact we already have had two consecutive quarters of negative GDP this year. I’ve found some analysts are reluctant to use the “R” word on the basis of that standard because the labor market still appears strong and spending remains relatively robust. For her part, Patterson acknowledges the still-positive data in the areas of labor and spending. But she also suggests conditions are in the throes of weakening.
“We’re starting to see delinquency rates on credit cards tick higher, for example, and we’re seeing confidence surveys fall considerably,” Patterson said. “So we think we’re going to see growth slowing.”
Patterson forecasts a stagflationary climate settling in largely because, in her view, the forces of higher interest rates and high inflation are likely to engage with one another in an uneven manner.
“The Fed’s in a really unenviable place,” Patterson suggested. “If they tighten too much, they risk exacerbating the recession. If they don’t tighten enough, they’re not going to get inflation where they want it and they could risk their credibility.”
The “clinical” definition of stagflation is an environment in which high inflation coexists with high unemployment and slow growth. But like El-Erian, Patterson doesn’t think a stagflationary reality has to be defined so strictly.
“We’re defining it broadly,” she said. “We’re just saying slowing growth and higher than expected inflation.”
That’s enough, in her view, to decide a stagflationary environment is in effect and make appropriate asset allocation adjustments. And among the assets she likes particularly well during periods of stagflation is gold.
Gold – and Silver – Soared Through 1970s Stagflation
Patterson’s reasoning is simple and direct. She says that Bridgewater analysts simply dug in “and looked at 100 years of economic scenarios and asset performance” to see which assets thrived under what circumstances. Among their conclusions: During those periods over the last century characterized by lagging growth and higher inflation, gold was one of the best-performing assets.
Americans who remember how metals fared during the country’s most infamous period of stagflation in modern history certainly need no convincing. From 1973 through 1982, average annual inflation never dropped much below 6%, and in four of those years – 1974, 1979, 1980 and 1981 – average annual inflation reached double digits. During the same period, monthly unemployment never dipped beneath 4.6% and at one point reached nearly 11%. As for gold and silver, both metals strengthened considerably from ’73 to ’82, rising 590% and 435%, respectively.
That said, it’s good to know gold has measured up as well as it has throughout stagflationary periods stretching back 100 years; not only does Patterson say stagflation is in our midst today, she says we may well have to trudge through a stagflationary environment for years.
Patterson foresees inflationary structural changes taking place throughout the global economy which – in combination with more cyclical influences – could result in persistent stagflation.
According to Patterson, one of those structural changes is a reduction in globalization. Globalization has served to place downward pressure on inflation for a variety of reasons. Among them: the facilitation of expanded trade routes and volume, as well as more reliance on high-functioning worldwide supply chains, the use of which has served to keep a lid on production costs.
Another of those structural changes – in Patterson’s view – is the deliberate worldwide move toward green energy, which she says will raise the cost of fossil fuels as supplies decrease. According to Patterson, these manifestations will make inflation – and, by consequence, stagflation – a more protracted feature of the economic landscape:
Those supports have to be taken into consideration along with the cyclical factors, which makes us think that stagflation is a real risk and people need to take a step back, look at their portfolios and say, “Do I have enough in my portfolio that if that scenario plays out, I’m not going to be vulnerable?”
Sounds like common sense to me.
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