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AAM Viewpoints — Welcome to Stagflation


“Stagflation” is generally defined as time periods with high inflation and low economic growth. While we believe that many markets have been in this camp for most of the year with interest rates rising while risk markets have declined, we think the Federal Reserve (Fed) also just joined the ranks. In the recent Fed meeting, the committee and Chairman Powell said they saw inflation staying high for an extended period while economic growth would slow almost to zero, meaning we are likely staring straight into the stagflation barrel. So, what does this mean for markets?

Looking at quarters with both high inflation and low economic growth, of which most were in the mid-70s and early 80s, we found several common themes.

First, as would be expected in periods of stagflation, inflation can be higher than the longer-term averages, but as you can see from the chart below, it has historically been much higher — more than 6% higher on average.

consumer price inflation
Source: Bloomberg | As of Date: September 30, 2022
Note: Based on 1960 to Present. High Inflation and Low Real GDP Growth periods are quarters with both top decile inflation and bottom decile real US GDP growth.

In this environment it may be helpful to position portfolios to include investments in companies that have the potential to perform well during higher inflationary times, especially when inflation can stay stubbornly high for some time.

Second, in periods of stagflation, market returns tend to be more muted, lower than long-term averages. As you can see from the chart below from periods during stagflation, markets have historically returned 7% less than the long-term average on an annualized basis. The returns still tended to be positive, just much less so.

himco2_101722_v2
Source: Bloomberg | As of Date: September 30, 2022
Note: Based on 1960 to Present. High Inflation and Low Real GDP Growth periods are quarters with both top decile inflation and bottom decile real US GDP growth. S&P 500 Returns are quarterly returns. Past performance is not indicative of future results. It is not possible to invest directly in an index. Indices do not include cash.

While returns can still be positive, based on history they can be lower than what is expected over the long run. Investors may want to consider having a more cautious positioning. This is especially true when you look at what happens to market volatility during times of stagflation.

S&P 500 return volatilitySource: Bloomberg | As of Date: September 30, 2022
Note: Based on 1960 to Present. High Inflation and Low Real GDP Growth periods are quarters with both top decile inflation and bottom decile real US GDP growth. S&P 500 Returns are quarterly returns. Past performance is not indicative of future results. It is not possible to invest directly in an index. Indices do not include cash.

During periods of stagflation, market volatility is significantly higher which makes sense. The higher uncertainty from not just slower growth, but potential distortions from higher inflation tend to lead to greater market uncertainty as is shown in the chart above. Historically, volatility on average rose by almost 3% during low growth, higher inflation environments, from 15.5% to 18.5%. We believe investors should not only potentially consider taking a cautious approach to the markets, but they may also want to consider positioning in strategies that seek to perform better in periods of higher volatility.

In the end, we expect to be heading into a period of low growth and high inflation, which the Fed also projected at their most recent meeting. In this environment we believe it is good idea to become a little more defensive and consider positioning portfolios to include investments that may benefit during times of increased inflation and have the potential to perform better during higher volatility.

 

CRN: 2022-1003-10366 R

The opinions and views of this commentary are that of HIMCO and are not necessarily that of Advisors Asset Management.  

The forecasts, opinions, and estimates expressed herein constitute the Hartford Investment Management Company’s (“HIMCO”) judgment as of October 11, 2022 and are subject to change without notice based on market, economic and other conditions. These opinions are not intended to be a forecast of future events, a guarantee of future results or investment advice. All data referenced is from sources deemed to be reliable but cannot be guaranteed as to accuracy or completeness. The assumptions may turn out be materially different from actual experience. These is no guarantee that any forecasts made will come to pass. Ref# 22-0113


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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