Some investors worry about the possibility of stagflation and a Great Resignation but the stakes for expansion are hardly at Squid Game levels. That popular Netflix series, which reaches more than 100 million viewers and achieved the biggest launch in streaming history, centers on conflicts among debtors and the deadly consequences for failure its contestants face.
Yet U.S. equity investors do face several dilemmas related to the health of the economic expansion and stock market rally.
Stagflation was a term born in the 1970s to characterize the high inflation that caused persistently anemic (often negative) real economic growth and high unemployment over that decade. While this backdrop scarred a generation, today’s circumstances bear it little resemblance: elevated near-term inflation co-exists, fortunately, with solid real economic growth and healthy labor markets.
September’s Consumer Price Index (CPI) inflation reading may have been 5.4%, but real third-quarter gross domestic product (GDP) growth continued to be positive, albeit at lower levels than earlier this year at 2.0%, down from 6.7% in the second quarter of 2021.
The high inflation reading may seem worrisome, but how the two measures are calculated can help to explain it. GDP is reported as a quarterly rate of change, then annualized, while CPI is typically quoted year-over-year (YoY). Using the same calculation that’s applied to GDP, CPI also slowed in the third quarter to 4.7%, down from a very high second-quarter reading of 9.7%.
Looking at core CPI the same way, the slowdown is even more dramatic: to 2.7% from 10.6%.
These declines in real growth and inflation suggest the culprit was not stagflation but rather a nationwide COVID-19 Delta variant-induced slowdown. Comments from the U.S. Federal Reserve’s Beige Book, as well as from corporate management teams reporting third quarter results, indicated that activity slowed meaningfully in late summer as Delta cases surged. As the latest wave of the pandemic receded in late September, economic activity re-accelerated.
NOVEMBER 8th 2021: Record high closings for all four major market indexes on Wall Street as the Dow … [+]
In the near term, inflationary pressures are unlikely to abate, although some pressures (such as supply chain bottlenecks) may be peaking. Despite ample worry, third quarter earnings results have been robust. With over half of the S&P 500 Index companies by market cap having reported, aggregate margins are set to expand and contribute 21% to bottom-line results.
Demand remains strong. Constituent company revenues are set to grow 15% YoY, suggesting little demand destruction thus far.
Earnings surprises also remain robust – a welcome development that helped drive the rally from early October lows.
As for the Great Resignation, the Job Openings and Labor Turnover Survey (JOLTS) shows a record number of Americans – nearly 4.3 million – left their jobs in August. Many firms report difficulty finding workers, and the news is full of stories about companies having to raise wages to attract them. What is less reported, however, is that the same survey showed even more August job hires/offers – 6.3 million to be exact – indicating the Great Resignation narrative is somewhat misplaced.
Nevertheless, this has become a buyer’s market for job seekers. There is elevated churn as some workers leave jobs in pursuit of higher wages. Wage gains generally paint a less dire picture of economic health. Average hourly earnings are up 4.6% YoY. The Atlanta Fed’s median wage tracker (+4.2%) and the Employment Cost Index (+3.7%) are also accelerating.
Although not pressuring corporate margins yet, wage growth remains a risk. Historically, it has been one of the longest leading indicators of a possible recession, but given the unique drivers of wage gains in the wake of the pandemic, wage pressures are likely to ease in 2022. Investors may be able to downplay, if not disregard, these concerns owing simply to seasonality.
Since 1950, November has been the best month for S&P 500 performance. December ranks third. History suggests that strength begets strength. When price returns through the first 10 months are in the top quintile, as they were in 2021, the index typically rises an additional 5%, on average, over the remaining two months, with positive returns 92% of the time.
Regardless of near-term performance, inflation and wage growth fears likely will dissipate as we move through 2022. This should provide further market upside as this new bull market matures.
Jeffrey Schulze, CFA, is a director and investment strategist at ClearBridge Investments, a subsidiary of Franklin Templeton. His predictions are not intended to be relied upon as a forecast of actual future events or performance or investment advice.
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