Against a backdrop of a U.S. labor market where there are more and more jobs openings but the participation rate remains depressed, the specter of stagflation, in the eyes of some, is materializing in markets. Rates on 10-year Treasury yields dropped to 1.12% last week, weighed down by a drop in so-called real yields -- which strip out the effects of inflation -- to an all-time low, suggesting traders see little growth ahead.
Supply crunches are boosting prices on big-ticket items such as houses and used cars, which is in turn crimping spending as consumers suffer sticker shock, according to Peter Boockvar, chief investment officer for Bleakley Advisory Group.
Such a stagflationary environment should benefit sectors with the highest degree of pricing power -- “energy, materials, even some consumer durables, if they can pass on higher costs to consumers, which they’re trying to,” Boockvar said. “P/E multiples would likely compress if this becomes sustainable and thus highly valued stocks would be most vulnerable and cheaper ones less so.”
With benchmark Treasury yields falling as low as 1.12% last week, investors are clearly pricing in some degree of stagflationary risk, BMO Capital Markets’ Ian Lyngen said. But unlike the full-blown stagflation seen in the 1970s, the current dynamic doesn’t stem from an external supply shock and unions no longer have the collective bargaining power to push wages higher -- meaning that should real growth rebound, the situation should resolve itself, the rates strategist added.
“This is a clear sign that it’s a potential risk,” Lyngen said. “However, if employment continues to improve and wages catch up, then real growth will also gain.”
Quadratic Capital Management’s Nancy Davis doesn’t see such an easy fix. While the oil market was the epicenter of the 1970s stagflation experience, it’s possible that higher labor costs or the ongoing semiconductor shortage could be the culprit in today’s economy.
“In a stagflationary environment, we would expect equities and bonds both to come under pressure. As investors sell across asset classes, correlations would increase,” Davis, manager of the $3.2 billion Quadratic Interest Rate Volatility and Inflation Hedge ETF, said in an email. “Stagflation is the traditional 60/40 portfolio’s worst nightmare.”
This article was provided by Bloomberg News.