2023 Inflation and Parallels to the Seventies

My most vivid memory of the Seventies is sitting in the car with my siblings and parents in a mall parking lot the week before Christmas and my mother crying because they couldn’t afford presents and had to file bankruptcy. For a 12-year-old it made the challenges of real life… real.

The seventies were a traumatic time for many Americans… the end of the Vietnam war, the political chaos of Watergate and Nixon, the oil embargo, gas rationing throughout the decade, the suffocation of unions, the loss of jobs and industries as Japan and South Korea became exporters. Economic instability was an ever-present cloud.

Moving in waves through the decade, the economy suffered from bouts of inflation and deflation. It made policy decision-making challenging at best… boost the economy to keep it from slowing down, or is the economy running too hot?

When you drill down one sees many similarities between conditions that led to the “stagflation of the 1970s” and the situation we find ourselves in today.

Valuation… Between 1950 and 1966 stock prices increased over 600%. (1) The economy expanded as soldiers returning from WW2 took advantage of the GI Bill and the work force improved rapidly. The US became a global superpower, and in the process expanded trade and markets. Companies expanded capacity to meet demand. By the mid-sixties markets had reached All-Time Highs (ATH).

By comparison between 2009 and 2022 the DJIA rose over 600%. (1) While the economy did expand, much of the increase in stock prices was driven by financial engineering… share buybacks, dividends, Quantitative Easing (QE), and leverage. By early 2022 with markets at ATHs overvaluation was comparable to market valuations in 2000 and 1929. (2)

Labor constraints… By the mid-sixties labor was becoming more constrained. The draft due to Vietnam pulled millions out of the labor market. In addition, the loss of life and wounds suffered, both physical and psychological pulled millions out of the work force permanently. The war created a lost generation that had real impacts on the economy. Labor shortages led to increasing wages.

In 2020 several forces conspired to disrupt labor. Anti-Immigration policies by the Trump administration cast a wet blanket over affected industries from high tech (H1B1 visas) to food production. With the advent of COVID, the economy was forced to shutdown and struggled to reopen. There was a huge loss of people who died as a result of COVID from the labor force… over 1 million people as of April 2023. In addition, there are several categories of people who are still missing from the work force. Studies show that 1 in 20 people infected with COVID survived but have permanent long term medical ailments. In the US that amounts to over 2 million people. (3) In addition, millions of older workers remain on the sidelines due to fear of COVID. Prior to COVID many workers in their 60s and 70s filled many service jobs, trying to make up for losses suffered in their retirement accounts because of the Great Financial Crisis in 2008. Yet another group leaving the work force are those deciding to retire early. A recent study by the New School estimates this number at 1.7 million people. (4) This cumulative gap explains the tight labor market. This is a labor deficit of over 4 million people. Going forward, it also offers little encouragement for new labor to come online and fill job listings. This has resulted in a new trend of higher wages which the Fed is very concerned about. In December 2021, Powell responded to a question from New York Times reporter Jeanna Smialek on high wage growth, “if you had something where [increases in] real wages were persistently above productivity growth, that puts upward pressure on, on firms, and they raise prices.” This stokes inflation over the long term. In November of 2022 Powell reiterated, “To be clear, strong wage growth is a good thing,” he said. “But for wage growth to be sustainable, it needs to be consistent with 2 percent inflation.” That will require reducing demand for labor by slowing the economy, he said. (5)

Inflation disruption… In the early 1970s the US went off the gold standard and injected chaos into currency markets. As global markets became more entwined, foreign trade partners affected US markets. OPEC imposed an oil embargo and caused prices for energy to spike higher. Shortages affected the economy as a whole. Japans economy increased production in the 1970s and exported more to the US. This new competition, and some would say dumping, hurt US businesses and the whole domestic supply chain. Disruptions in production led to disruptions in supply chains which in turn led to periodic spikes in commodity prices. As the economy slowed and companies experienced higher commodity and labor costs, they tried to maintain profitability and cash flow by raising prices.

Following the COVID shutdown in 2020, the economy has struggled to reopen. Supply chains have been severely disrupted, a victim of the corporate faith in cost savings and “just-in-time” transportation. A prime example is the shortage of microchips affecting businesses as diverse from autos to home exercise equipment. In addition, the global impact of COVID has affected commodity production worldwide, raising prices for US businesses and forcing them to pass on these price increases to consumers. Add on top of this the Russian invasion of Ukraine, commodity production has led to worsened shortages that have helped fuel inflation.

These three broad similarities can offer some guidance to how one can manage risk in the years to come. Key among these is the need to understand that there are periodically conflicting forces at work, both inflation and deflation… this can lead to policy mistakes both in terms of fiscal policy (government spending) and monetary policy (interest rates). In the 1970s this economic condition was called “Stagflation”. Understanding this affects an investor’s decision-making, risk tolerance and expectations.

In the Spring of 2023, the Federal Reserve is struggling to not fall into the trap that drove the behavior of Fed Chairman Arthur Burns in the 70s. As the economy slowed, Burns and the Fed lowered interest rates. While this eventually stabilized the economy, it ended up driving inflation to still higher levels. By the end of the 70s inflation reached 15%. In May of 2023, the economic data show an unemployment rate of 3.4%, Core Inflation at 5% and headed higher not lower, and wages increasing. The Fed has committed to reducing inflation to 2% and still has a lot of work to do. While the economy is slowing and appears to be going into recession investors should not expect lower interest rates anytime soon. (6)

Some aspects of today’s economic situation are unique. The Fed’s policy to use QE and other extraordinary measures as they did in 2020 to support debt markets… The hiking of rates over the past year to curb inflation… the excessive borrowing by corporations over the past 10 years, even for companies that are unprofitable… rising economic nationalism to bring jobs and manufacturing back onshore, especially in regard to China… Rising temperatures and climate change are affecting economies and societies worldwide, and these impacts are worsening…

There will be challenges and opportunities that will arise in the coming decade. Working with an advisor who understands the economic environment and the forces shaping it can help in managing risk. If you have questions, please reach out to me at james.cox@glic.com

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James Cox

Cell: 267 323 6936

Email: james.cox@glic.com

Park Avenue Securities 150 South Warner Rd. Suite 120 King of Prussia, PA 19406

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Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 150 S. Warner Road, Suite 120, King of Prussia, PA 19406 (610)293-8300. Securities products and advisory services offered through PAS, member FINRA, SIPC. PAS is a wholly owned subsidiary of Guardian.

2023-155947 exp 5/25

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