Was the COVID recession a traditional recession in the sense that it represented the bridge from the end of one economic cycle to the start of a new economic cycle? Or, might it be more aptly thought of as a war that interrupted/disrupted an ongoing economic cycle? If the answer is the latter, it helps explain some of the economic and inflation data that looks eerily late-cycle. Although we do not believe the pillars are yet in place to support a 1970s-style stagflation scenario, we are clearly in a weakening growth/high inflation era that appears less “transitory” every day.
See the Merriam-Webster dictionary definitions of stagflation and transitory.
Although inflation is behaving with “persistence,” consumer demand is not “stagnant,” and the unemployment rate has been falling amid a very tight labor market. Interestingly, there is a dual definition of “transitory,” with inflation not falling in line with the “brief duration” definition—even if it might ultimately qualify for the “not persistent” version of the definition.
In recent reports, I’ve been highlighting the vastly different trajectories of economic and inflation surprises. The charts below show how economic data and inflation readings are coming in relative to consensus expectations. Although a bottom may have formed for economic surprises, they remain in negative territory; and although a top may have formed for inflation surprises, they remain historically stratospheric. As shown in the accompanying tables, the S&P 500 has historically had weak performance in these zones. Interestingly though, when inflation surprises have run hot historically, small cap stocks tended to outperform a larger cap index like the S&P 500.
Economic Surprises Weak
Source: Charles Schwab, Bloomberg, ©Copyright 2021 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/, as of 10/15/2021. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.
Inflation Surprises Elevated
Source: Charles Schwab, Bloomberg, as of 9/30/2021. The Citi Inflation Surprise Indices measure price surprises relative to market expectations. A positive reading means that inflation has been higher than expected and a negative reading that inflation has been lower than expected. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.