An Emerging Threat of Stagflation?

Market prices were generally higher this week. Precious metals, energy, and most other commodities were strong, while the dollar dropped. Among the major indexes, the S&P 500 and the Nasdaq were positive, but the Dow Jones finished lower for the week. Despite mostly higher prices, there were some underlying signs of trepidation. Consumer staples outperformed consumer discretionary stocks over the week, and the defensive sectors of health care and utilities both outperformed. 

In addition, on Friday, despite the fact that the Nasdaq was the only major index to close higher, it managed that feat on very weak breadth as 2,028 of the over 3,000 total Nasdaq stocks closed lower. Meanwhile, the elevated volatility that characterized last month was noticeably absent this week. With that said, the decline in volatility may have had more to do with the end of summer and Labor Day preference for beaches and beer over spreadsheets and trading desks than a lack of impactful market developments.

The biggest headline news this week came on Friday when the US Labor Department reported the much-anticipated August non-farm payroll numbers. The monthly payroll numbers are always one of the most important and highly followed data releases on the economic calendar, but the measure carries added significance these days as it has direct implications for future Federal Reserve monetary policy decisions. At the height of Fed hawkish market sentiment following last month’s impressive July payroll number, many Fed officials and market commentators expressed the view that a Fed tapering program was soon to follow in the event of another strong monthly payroll number for August. 

On Friday, the Champagne remained corked and the tapering plans were put on ice for the time being as the payroll number was a very big disappointment. The Labor Department reported that 235,000 jobs were created last month as opposed to the roughly 750,000 jobs economists had expected. The much-weaker-than-expected report poured more cold water on the strong economic recovery theme, and added further fuel to the market’s dovish interpretation of Fed monetary policy intentions that followed from Fed Chairman Powell’s Jackson Hole speech last week. Despite the weak payroll number, the market largely shrugged off the news and didn’t seem to know how to react. The markets neither sold off aggressively in reaction to another weak economic data point, nor rallied aggressively anticipating that the implications would translate to an extension of ultra-accommodative Fed monetary policy.

In addition to the payroll number, this week also saw two more significant downward GDP revisions by major US banks. Goldman Sachs lowered its Q3 GDP tracking estimate from 5.25% to 3.5%, while Morgan Stanley went even further, lowering their Q3 GDP forecast to 2.9% from what had already been a downwardly revised 6.5%. At the same time, on Thursday, the Federal Reserve Bank of Atlanta downwardly revised their GDPNow model estimate for real GDP growth in Q3. Their model has been in free-fall all year, and the latest number is down to 3.7% from levels well over 6% as recently as early August.

The Atlanta Fed also added that, in light of “this morning’s releases from the Bureau of Economic Analysis and the U.S. Census Bureau, the nowcasts of third-quarter real personal consumption expenditures growth and third-quarter real gross private domestic investment growth decreased from 2.6 percent and 23.4 percent, respectively, to 1.9 percent and 19.3 percent, respectively….”

This week’s poor jobs number, plunging consumer sentiment, a slew of weakening economic data, and GDP forecasts underscore the reality of emerging growth concerns. All hope for economic growth and Fed taper plans is not lost, however. Over the last two weeks, data on the delta Covid variant has turned more positive, and suggest we may be past the peak. Although there appears to be much more to slowing economic growth data than Covid alone, if Covid concerns can materially decline for a sustained period, that will carry significant positive economic implications. 

In addition, enhanced unemployment benefits for unemployed U.S. citizens are set to expire this weekend. According to Century Foundation, the expiration means that roughly 8.8 million individuals will lose their enhanced benefits in full, while an additional 3 million individuals will have their aid reduced. Many analysts believe that removing enhanced benefits will prompt increased job seeking and act to boost future payroll numbers. Some results from states that have already ended enhanced benefits support this idea, but the degree of impact to overall job numbers remains to be seen.

Interestingly, information from abroad suggests that labor issues are not isolated to the U.S. If they were, it would be easier to chalk up payroll weakness to domestic policies. A recent KPMG survey found that the vast majority of Canadian businesses are experiencing staffing shortages, and cited employment challenges as the top threat for future growth. Globally, the story remains the same. ManpowerGroup has reported that employers across the globe are struggling to fill open positions. Nearly 70% of global businesses claim to be unable to fill positions, and, according to ManpowerGroup, that figure represents a 15-year high. 

U.S. enhanced unemployment benefits cannot be responsible for what appears to be a global phenomenon. What is causing the labor challenges globally and domestically is not entirely clear. The end of enhanced unemployment benefits in the U.S. may well help, but a weakening trend in economic data will not. So, the next set of monthly payroll numbers will be even more important, and will be closely watched after the August disappointment. Similarly, positive developments on the Covid front will be crucial both for individuals and to provide a possible counterbalancing boost to sagging economic data.

Meanwhile, data this week confirmed that home prices are soaring. According to the S&P CoreLogic Case-Shiller US National Home Price Index, prices have reached a record high. Average home prices jumped to 18.6% in June from 16.8% in May. This represents the largest increase since 1987 when the data was first collected. Home prices are now over 40% higher than the peak reached during the last housing boom prior to the Great Financial Crisis. While the Owner’s Equivalent Rent figure in the government’s CPI calculation tends to be a lagging indicator that will likely start moving higher more aggressively in the coming months, it is a deeply flawed metric to capture housing related inflation. Regardless of the degree to which CPI captures what is ongoing in the housing market, there is no doubting the inflationary implications of the launch higher in home prices.

One thing that is becoming increasingly clear week after week is that the combination of weakening growth and economic data along with stubbornly non-transitory inflation is rapidly increasing the risk that stagflation is threatening to establish itself and take hold of the economy. Most market participants have never allocated capital in a stagflationary environment, so it remains to be seen how markets will respond if these trends continue into the autumn. As the investment community returns from Labor Day beaches and beer, we may well see a return to more volatility as some of these questions begin to be answered.

As for weekly performance: The S&P 500 closed the week up 0.58%. Gold was up by 0.78%, and silver rallied 3.07% on the week. Platinum gained 1.50%, while palladium was up 0.34%. The HUI gold miners index rallied 1.41%. The IFRA iShares US Infrastructure ETF was slightly lower on the week, shedding 0.08%. Energy commodities were higher. WTI crude oil gained 0.80%. Natural gas was in rally mode, gaining 7.34% on the week. The Commodity Research Bureau Index was up 0.42% on the week, while copper was nearly flat, up just 0.05%. The Dow Jones US Real Estate Index ended the week up 3.14%, while the Dow Jones Utility Average Index gained 1.36%. The US Dollar Index dropped for the second consecutive week, losing 0.71% to close the week at 92.03. The yield on the 10-year Treasury gained 2 bps to close the week at 1.33%.

Have a great weekend!

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC