Stagflation describes an economic setting in which inflation increases while economic output slows or stops. This condition was first seen in the US in the 1970s when the country experienced five quarters of negative GDP growth.
Stagflation is beginning to surface in conversations today because economic growth appears to be weakening and inflation appears to be on the rise.
Recently, the I.M.F. issued a warning that “pandemic outbreaks in critical links of global supply chains have resulted in longer-than-expected supply disruptions, further feeding inflation in many countries.” In the same report the I.M.F. reduced their US economic growth forecast from 7% to 6% while reducing their economic growth forecast at the global level from 6% to 5.9%.
Forecasts of rising inflation have also been seen outside the I.M.F. The Federal Reserve Bank of New York’s Survey of Consumer Expectations showed that inflation expectations over the next three years have increased from 4% to 4.2%. Meanwhile, short-term expectation increased by 5.3%.
Investors are taking note of these changes because stagflation tends to lead to lower equity returns. Consider research from the World Gold Council which shows that since 1973 the S&P 500 has delivered an annualized average (stagflation) adjusted return of -6.6% during periods of stagflation. EAFE equities fared even worse during episodes of stagflation generating a return of -11.6%.
Investors are growing fearful. These negative historical returns are prompting many to seek alternative investments to offset the possible risk of a looming stagflation period. The same data reveals what assets performed well during the same stagflation periods that yielded negative returns for equities. The clear winner is gold which rewarded savvy investors with a return of 32.2%.
This return was by far the strongest of all the asset classes studied. The next best performer was the S&P GSCI investible commodity index which delivered a return of 17.5% for the same stagflation periods.
Importantly, the analysis shows that gold offers strong returns during other economic cycles including reflation, and deflation when returns were 8.4% and 12.8% respectively.
Most investors are reaching a critical juncture as equity forecasts are dimming amid supply chain disruptions that are likely to drive up inflation for the foreseeable future. The picture that is coming into focus is not one of rebound, and recovery. Rather it is one of transition. While the COVID pandemic in the US is improving for the moment, there are certain to be reverberations felt for the years to come as the economy makes the long journey back to something resembling normal.
While the economic conditions in the US are poised for stagflation it is important to remember that knowing the when and where of such an event is impossible. For this reason, some investors may want to consider gold as a permanent part of their asset allocation strategy.
After all, gold has enjoyed a strong performance since 2018 and continues to act as a hedge against other threats like counter-party risk, and corporate tax changes.
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