Stagflation Is Becoming the Baseline Economic Scenario
New economic numbers show growth slowing and inflation remaining stubbornly high.
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The market got a double whammy on the economic news front on Thursday. Initial estimates for first quarter GDP growth came in at just 1.6%. This was less than half the 3.4% GDP growth in the previous quarter and far below the 2.3% GDP growth that was expected. In fact, growth came in slightly under the lowest analyst firm estimate.
Even worse for investors was that the PCE Index (the Federal Reserve’s favorite inflation indicator) rose to 3.4% from just 1.8% in the previous quarter. Core PCE, which excludes food and energy, also came in hotter than expected with a reading of 3.7%. This was up from 2% in the final quarter of 2023.
The market held up remarkably well given this unexpected jolt with the Dow losing just under 1% and the S&P off less than a half of a percent, while the Nasdaq posted a decline of just less than two thirds of a percent. First quarter earnings results have mostly come in higher than expected, although guidance from the likes of Meta Platforms META and ServiceNow NOW was more than tepid yesterday.
My regular readers know that I have been banging the drum for stagflation, or as Doug Kass would call it Slugflation, for several quarters now. Yesterday’s GDP and PCE numbers just reinforced that view and I think that should be investors baseline economic in the months ahead. In short, inflation is likely to remain ‘sticky’ and interest rates will remain ‘higher for longer’.
While the Fed Funds rate has been boosted by more than 500 bps since March of 2022, the central bank is getting little help from the administration on the fiscal front. It is very hard to get a handle on inflation, outside of a recession, when the federal government is spending $150 billion to $200 billion more a month than it is taking in.
This massive amount of deficit spending boosts economic growth in the short term, but it is not sustainable. Especially given the United States already has the highest GDP to debt ratio in its history. Foreign financial institutions have slowed their purchases of US Treasuries in recent years and many central banks are buying record amounts of gold. Given that, I expect yields on Treasuries to remain elevated, which should continue to be a substantial headwind for equities.
I also expect the jobs picture to darken in coming quarters. Companies have hoarded workers since the employee shortages caused by the pandemic. However, that reluctance to lay off staff should ebb as corporations struggle to maintain profit margins in an environment of slower growth and stubborn inflation levels.
In recent weeks we have seen significant job cut reduction notices at Southwest LUV, Tesla TSLA and Bristol-Myers Squibb BMY. 99 Cents Only recently went into bankruptcy and Red Lobster is trying desperately to avoid the same fate.
Stagflation is hardly a positive for the overall market and I expect P/E multiples to come down as equities at some point have a significant decline. I also would imagine the market will remain quite bifurcated as investors continue to pile into stocks of companies that can post stellar growth in this increasingly challenging economic environment, such as Microsoft MSFT and Alphabet (GOOGL).
Not exactly a happy note to end the trading week, but it is becoming more apparent that the probability of stagflation settling in across the economy is growing.
At the time of publication, Bret Jensen had no position in the securities mentioned.
