It’s become popular to compare and contrast the similarities of today to 1970s’ inflation. But there are some glaring differences, Loomis Sayles vice chairman Dan Fuss explained to accredited investors at a conference sponsored by The Money Show in Brooklyn earlier this week. Fuss, economist Ed Yardeni and publisher Steve Forbes all spoke individually and then participated in a wide-ranging panel discussion that touched on issues including changing consumer behavior patterns, monetary policy, corporate governance and climate change.
In Fuss’s view, the Fed’s initial moves to expunge inflation, though late in the minds of many observers, were dramatic—as the central bank raised rates nearly 4% in less than one year. Back in the 1970s, the Fed approached incipient inflation far more gingerly and the nation ultimately paid a heavy price late in that decade.
The “long and variable lags” to monetary policy described by Nobel laureate Milton Friedman, which can take up to 18 months to influence economic activity, are just beginning to play out. The economy “is weakening but it may not go negative,” he said. It's quite possible, however, that the Fed's aggressive policy has yet to hit the economy and, if it hits hard, the central bank might "have to have back off."
In the meantime, the world is changing physically and geopolitically. Fuss’s grandson recently went to Alaska to attend an ice festival only to find no ice.
Meanwhile, geopolitical boundaries in East Asia and Western Russia are being challenged. How does this affect capital? American financial markets look very attractive to Asians. In Boston’s affluent suburbs, housing prices are being bid up by new foreign residents and investors, often from that region.
Fuss sees inflation going down to the 4% area in the near future—and it could eventually bottom out at 3.0%. He thinks investors could witness “a modest replay of the 1970s” without the hyperinflation that occurred late in the decade.
For now, he sees interest rates rising about 1.0%, possibly a little less for Treasurys and more for bonds with less attractive credit characteristics. Ten-year Treasury yields could “push 5%” and “corporate spreads will widen just a bit.”
A 6.0% yield on the 10-year Treasury would be the “extreme outcome.” Yet Fuss acknowledged it was possible in the next cycle. Outlays on defense spending are headed higher, he added, which will likely sustain some inflationary pressures.
Yardeni observed that the economic data is sending mixed signals while most sentiment indicators are pessimistic. Leading economic indicators peaked in February 2022 and have been flashing recession signals for months now, but coincident indicators reflecting the current status of the economy are “healthy,” he said.
At some point, markets are likely to send a warning to the Fed. If it keeps raising rates, the Fed is likely to see lower rates on long-term bonds, Yardeni continued. “At some point, the economy is going to blow up,” he noted.
But Yardeni isn’t convinced that will happen. Indeed, he confessed to expecting something of a soft landing or even a “rolling recession” like the one in the mid-1980s that fails to turn into an actual recession. In the mid-1980s, the price of oil collapsed, triggering a crash in the banking and real estate industries in Texas and Oklahoma. But low energy prices provided a lift for many other regions.
Right now, there appears to be a goods recession, many of which were purchased aggressively during the pandemic. But some big-ticket services like travel are prospering and display no signs of a slowdown. People thought the tech boom was going to last forever as it did in the Y2K era, but investors once again learned otherwise. “A rolling recession may not add up to a technical recession,” he said.
Today, the housing market has experienced a noticeable slowdown, but “we haven’t seen a calamity,” Yardeni said. Demand is weak, but the supply of homes for sale also is anemic.
The financial markets exhibited numerous mini-bubbles, from SPACs to meme stocks to Cathie Wood stocks to crypto, which Yardeni dubbed "digital crypto." But he admits to being hard-pressed to identify anything that "really looks like a credit crunch. There is no problem getting credit; it's just more expensive."
Many are still asking whether inflation is transitory or persistent. Yardeni said it was both. Like Fuss, he noted costs for some things like food and energy are permanently higher, but many businesses are now finding resistance to price increases in other areas.
Yardeni has been in the soft landing camp all along and he puts the odds on that scenario somewhere near 60%. He also said he believes the stock market bottomed on October 12 last year. Among his favorite sectors are energy and industrials, with the latter benefiting from infrastructure spending.
Forbes Media chairman Steve Forbes chose to bring a political lens in his talk, which focused on what strategies Republicans should pursue to position themselves for the 2024 election. Chief among the strategies he favored should be highlighting the disparate economic performances of red states versus blue states since the outbreak of the pandemic. “What happened in Florida indicates what can happen” on a national level, he said.
States should also be treated as laboratories for popular policies like Educational Savings Accounts (ESAs), which Arizona and other states are introducing.
Forbes was highly critical of the Democrats’ green energy agenda and he pinpointed some areas where it was downright self-defeating. A relatively small number of wind farms use more plastics than all of the plastic straws in the world, he claimed.
Moreover, the global cloud computing universe includes many companies favored by ESG investors and mutual funds but it uses more energy than the entire nation of Japan, he said.
“The far left is trying to impose socialism” through regulations and policy prescriptions, he continued. One result is that small companies will no longer consider IPOs because they can’t absorb the massive costs of the SEC’s new ESG reporting requirements.
Forbes was also quite critical of the Fed, saying they might serve the public better as a think tank that only became activist in the event of financial crises. He voiced a wish that the central bank could get over its Philips Curve obsession, namely the view that there is a significant trade-off between inflation and unemployment. Most mainstream economic research in recent years has punctured this notion that prevailed as gospel back in the 1970s. In the previous decade, the U.S. economy simultaneously enjoyed inflation rates of 2% and unemployment rates below 5% for six years prior to the pandemic.