Stagflation or Recession: Where Does This Leave the Investor?

It’s no shocker that global stock markets are going through unprecedented turmoil at the moment. While Russia’s war on Ukraine takes a new twist and turn every day, stock markets are also mimicking the ups and downs. Due to Russia’s status as a major supplier of oil and other raw materials, commodity markets are reflecting the tumult with soaring prices.

Fears of an oil shortage took hold of the markets on Tuesday as the U.S. Government announced a ban on Russian oil imports. This resulted in oil hovering around the $126 a barrel mark resulting in analysts predicting oil to soar to between $150 and $300 a barrel.

However, on Thursday, oil pulled back from its soaring prices with West Texas Intermediate (WTI) crude oil settling around $110 per barrel. According to a CNBC report, Brent crude oil suffered its largest drop since April 2020, falling 13% to $111.1 barrel.

The geopolitical tensions, supply chain constraints, and rising inflation have given rise to fears about stagflation. But what is stagflation?

Stagflation

Stagflation is an economic condition where inflation and unemployment are high and the economic growth rate slows down. Most economists consider stagflation a dilemma for economic policy as most measures for reining in inflation only result in driving up unemployment, thus exacerbating the issue

Currently, the conditions are ripe for this detrimental environment to materialize, according to most economists. A Bloomberg report quoted Maurice Obstfeld, a former chief economist at the International Monetary Fund (IMF) which read, “‘The more protracted this period of continuing shocks,’ the more likely it will be that economies will suffer ‘something like the 1970s experience.'”

The 1970s era of stagflation that economist Obstfeld is referencing occurred from the period of 1973 to 1975, when oil supply was restricted due to geopolitical developments. Stock markets crashed around the world and unemployment in the United States soared to a new high.

By an estimate from the U.S. Bureau of Labor Statistics, 2.9 million jobs were lost in the U.S. during the severe recession from 1973 to 1975. This even exceeded the post-World War record of a loss of 2.3 million jobs.

Let us look at whether the U.S. economy is heading for such an environment.

State of the U.S. Economy

Going by the recent Q4 numbers regarding the U.S. economy, it does not seem to be heading for stagflation.

According to the Department of Labour data from March 3, in the week ending February 26, seasonally adjusted initial unemployment claims declined 18,000 over the previous week to 215,000. Even more encouraging, was that according to this update, the four-week moving average for seasonally adjusted insured unemployment was 1.54 million, its lowest level since April 4, 1970.

Even Real Gross Domestic Product (GDP) numbers for the U.S. economy are encouraging for Q4. Real GDP is an inflation-adjusted measure that measures the value of all goods and services produced by an economy each year.

According to the U.S. Bureau of Economic Analysis, in Q4, real GDP rose 7% in Q4, while in the prior quarter (Q3) it had increased by only 2.3%. More importantly, this rise in real GDP was fuelled by rising exports, higher consumer spending, and investment in inventories.

It remains to be seen what the Q1 numbers and the latest unemployment claims data could indicate, but for now, the numbers don’t seem to support stagflation.

Recession Fears Overdone?

The Fed has been signaling an imminent hike in interest rates for quite some time now. In a recessionary environment, if the Fed hikes interest rates, the expectation is that this could cool down inflation.

An NPR report from this morning quoted Fed Chairman Jerome Powell, stating that “The economy is very strong. Unemployment is low. Wages are going up. The labor market is quite healthy, and inflation is all too high.” These comments came as he asserted his case to the U.S. Senate.

Additionally, the recent earnings from big corporate players had all pointed to supply chain constraints easing up gradually, as well as overall macroeconomic optimism about Q1.

However, the current geopolitical situation being what it is, there are bound to be economic repercussions from this crisis. Whether this will result in a deep long-lasting recession remains to be seen.

What about the Investor?

In such an uncertain scenario, ordinary investors could wonder whether it is time to exit the market. On the contrary, many would argue that it is time to stay invested in the market.

For a long-term investor, as stock markets turn bearish, it may be time to gravitate toward stocks that offer an effective hedge against inflation, or can benefit from an uptick in commodity prices. The TipRanks database offers investors a tool to screen such stocks.

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