Forget the 1970s, the ‘stagflation’ playbook may be 2005: McGeever

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ORLANDO – With rising prices and slowing economic growth, many investors are looking to the past in an attempt to guess where the US markets will go next. While the “stagflation” of the 1970s brings back memories, investors may want to revisit the mid-2000s.

In both periods of energy prices, inflation expectations and bond yields rose, along with anemic growth and central banks moving toward tighter monetary policy. However, the mid-2000s were much milder.

While all market and economic cycles are unique, none more so than the last 18 COVID months of recession, rebound and inflation caused by bottlenecks and supply shortages, the conditions that exist today are more similar to what occurred in 2005.

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As in 2005, US equity valuations are now falling gently. The S&P 12-month price-to-earnings ratio is now around 20.5, down from 23 a year ago, reflecting the decline to 14 from 16 over the course of 2005.

That downward trend continued into 2006. Given that P / E ratios remain historically high, there are many reasons to expect this trend to extend into next year and potentially accelerate if the third-quarter earnings guidance is grim. .

The S&P 500 experienced two mini-corrections in 2005, the first of 8% in March-April and then a reduction of 6% in September-October. The index just had its first 5% drop in nearly a year, and according to nearly two-thirds of the more than 600 market professionals recently surveyed by Deutsche Bank, a correction of 5% to 10% is forecast by the end of anus.

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Some analysts have started to point to the mid-2000s as a possible case study. Morgan Stanley’s Andrew Sheets wrote in a note Sunday that 2005 was “a recent and interesting example of a stagflation scare after a mid-cycle transition.”

CALM OR COMPLACEMENT?

In some key respects, the inflation outlook is also more like 2005 than it was in the 1970s.

Headline annual inflation is now just above 5%, the highest in 13 years, compared to a peak of just under 5%, a 14-year high. There is no sign of the double-digit impressions of the mid- and late-1970s, a period of a severe spiral in prices and wages.

The inflation of the 1970s is correctly associated with shocks and energy shortages. But the mid-2000s saw notable increases in oil and natural gas prices that were the main drivers of the widespread rise in consumer prices. Like today.

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Brent crude more than doubled to $ 65 a barrel in late 2005 from around $ 30 in early 2004. It has more than doubled in the last 18 months to $ 83 a barrel, and will test the $ 100, according to a report. Majority Opinion in Deutsche Bank Investor Survey.

US natural gas futures recently hit a 12-year high above $ 5,565 per million British thermal units after rising nearly 40% in just six weeks. In July-August 2005, natural gas prices rose by around 50% to an even higher record, just shy of $ 14 / mmBtu.

Investors and policymakers certainly need to be vigilant as breakeven inflation expectations rise along the curve toward multi-year peaks in May. For the US 5-year rate, that’s around 2.80%, and the last time it was above that level for more than a few days was in 2005.

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Call it calm or complacency, but Wall Street seems relatively relaxed. The VIX Implied Volatility Index on the S&P 500 has mostly traded below 20 since March, suggesting equity markets are comfortable with higher expected future levels of inflation, interest rates and bond yields. .

As Morgan Stanley’s Sheets points out, inflationary markets mean that price pressures will moderate over time, rather than spiraling. Additionally, nominal interest rates are low and stock valuations are near record highs.

In the 1970s, the opposite of everything that happened happened.

“If ‘stagflation’ means ‘the 1970s,’ a time of price and wage spirals and high unemployment, it is clearly not this,” he said.

(Reporting by Jamie McGeever; Editing by Steve Orlofsky)