If Goldilocks lives on Wall Street, she isn’t happy to hear that U.S. companies are still hiring even while unemployment is already well below 4%. That’s too hot for comfort . . . and today proved that investors are actually more afraid of the economy running too hot than the alternative.
That’s a slightly paradoxical position worth unpacking in a market that arguably reflects 100% odds of a recession on the horizon. How do you swing from too hot to too cold without a transition period in between?
After all, the real nightmare for many investors is a return of 1970s-style stagflation. We’re already living with the “-flation” part of that proposition, with consumer prices racing at their fastest rate in decades.
But to get the “stag-” you need ambient heat to vanish from the economy and leave stagnation behind. More specifically, you need persistent elevated unemployment . . . a lot of people out of work for an extended period.
That’s just not showing up in the data. The numbers are moving in the opposite direction. And that’s an opportunity for investors with courage to buy the gloom and hold on for a brighter future.
Just go back to the early 1970s to see how it works. Yes, the S&P 500 lost nearly half of its value over a slow, grinding 21 months. When it finally bottomed, unemployment was climbing toward an eventual peak of 9.0% . . . and throughout the process, inflation remains a constant drag.
It took buy-and-hold investors a harrowing six years to make money again. Money put into the market back in 1973 wouldn’t show even a penny of paper profit before mid-1980. That’s a long time to “stay the course,” especially when the economy isn’t exactly giving you a lot of reason to cheer.
We got through it, of course. The oil shocks eventually lost their power to unhinge the economy. The Fed kept delivering tough medicine, with breaks for recovery in between.
In 1974, overnight lending rates hit a high close to 13% before trending lower for the next three years. No central banker wants to antagonize investors. When stocks stalled, rates came down.
And there were plenty of upswings within that long “lost” decade. You just needed to keep your eyes open and cash out from time to time.
I count at least 6-7 chances to squeeze 10-30% out of the S&P 500 between the 1972 peak and the final push back into bull market territory eight years later. Add them all up and an alert trader could have made 7-10% a year without too much effort.
That’s actually close to the long-term historical average, business as usual on Wall Street. A buy-and-hold investor would of course have made nothing over that period.
The time for buy-and-hold gains came in the following decade and beyond. If you were patient enough to stick with the S&P 500 through a 48% loss, you would have had to accept that the index would be worth as little as 60 at the bottom.
Here at 4108, a half century later, the power of patience is clear. The economy is a cycle. Even stagflation is a passing phase.
And I don’t think stagflation is inevitable yet. We aren’t going back to the 1970s until the discos reopen . . . and right now, we have the “flation” but the job creation numbers simply don’t align with the “stag.”
Inflation plus a vibrant economy is actually a good thing. Too much heat and too much inflation makes us all nervous, but it’s a whole lot better than the alternative.
I think the Fed is already getting results and inflation is receding. In that scenario, we’re left with a somewhat cooler economy and much more comfort on pricing. That’s not the end of the world. It’s actually the status quo on Wall Street.
But if you’re worried about a lost decade, don’t run for the sidelines. Buy the dips. Sell the peaks. Keep money moving.