Is Stagflation Coming Back? Economist Sees Parallels With the 1970s—and Big Differences.
Martin Barnes, longtime chief economist at BCA Research, in 2011.
Daniel Acker/Bloomberg
He hardly qualifies as a member of the Great Resignation movement, but Martin Barnes will be retiring as chief economist at BCA Research at the end of the month. After nearly a half-century toiling in the dismal science, including the past 34 at BCA, he marvels at others who are years and even decades his senior, and, “with more money than God,” still eagerly keep at it.
Before Barnes heads home to Scotland to be closer to his children and grandchildren, we sought his perspective on the current investing scene, a perspective gleaned by living history, rather than reading about it. A long-term view is sorely lacking among many younger investment watchers, given that anyone who has been in the markets since the 2007-09 financial crisis has learned that it’s always best to be fully invested, he observes in a telephone chat before departing Canada, BCA’s home base.
Barnes’ career has been bookended by wrenching crises—the oil price shock of 1973 and now the Covid-19 pandemic. He cautions about drawing too-close comparisons with past episodes, however. “At any given point, you can find five or six similarities, but also 27 differences,” he adds, dismissing analogies to the 1920s after World War I and the flu pandemic.
In particular, the 1970s were very different from today, he continues. Inflation then was embedded in the behavior of business and labor. Policy makers underestimated its persistence, while bond investors completely miscalculated how high inflation could rise. They kept accepting yields well below the rate of inflation, resulting in negative real returns. Ultimately, they suffered catastrophic price declines, as yields soared into the mid-teens for top-grade securities.
Déjà vu all over again? The real interest rate on 10-year Treasury inflation-protected securities now is negative 0.96%, which implies an anticipated inflation rate of 2.64% over the next decade, an optimistic forecast that is about half the 5.3% rise in the consumer price index in the latest 12 months. Thus, the bond market again is accepting negative yields and the idea that inflation will be transitory, to invoke the mantra favored by the Federal Reserve and some other policy makers.
The difference between then and now is that the Fed is anchoring short-term interest rates near zero while continuing to buy Treasury and agency mortgage-backed securities. This represses bond yields, Barnes says, resulting in a shortage of low-risk assets. He adds that he sympathizes with the “secular stagnation” thesis of former Treasury secretary Lawrence Summers, which suggests that we will see persistently low growth, inflation, and interest rates held down by demographics and heavy debt loads.
That said, artificially cheap money risks feeding asset bubbles, from house prices to parts of the equity market. Eventually, this leads to misallocation of capital, the veteran economist adds, a polite way of saying too much dumb money will be chasing too few good investments (and not a few bad ones).
In addition, the pendulum is swinging back in favor of labor, something that happens with regularity over time, Barnes points out. The disinflation of the past four decades came about as capital got the upper hand from productivity gains and globalization, sending profit margins sharply higher. Now, tight labor markets are putting downward pressure on margins.
So what’s an investor to do? That elicits a laugh from the usually dour Scot. The macro environment still favors stocks, with dividends having an advantage over bond yields. Equities also are likely to fare better if bond yields rise. “But, but, but,” he adds for emphasis, longer-term returns are likely to be poor, in light of the current exalted stock valuations: “If you’re expecting 6%-7%-8%-9% returns over the next X years, that’s not going to happen, in my view.”
A 2%-3% risk premium for equities over bonds isn’t much, he continues. In the short term, however, the trend remains positive, based on his reading of the technical charts, since the major indexes are still above their rising moving averages, a classic positive trend. Another 10% gain over the next six months is possible, he adds, but it’s also impossible to time a sharp correction of 20% or more.
Those who have been in the market for only the past decade or so, however, have repeatedly been proven right to remain fully invested. And Barnes recalls the famous observation of economic historian Charles Kindleberger that “there is nothing so disturbing to one’s well being and judgment as to see a friend get rich.” Presumably, it’s twice as frustrating to see somebody tap on a phone app that spews confetti with crazy trading gains.
Read more Up and Down Wall Street:Cheap Money’s Lifting Just About Everything. Enjoy It While It Lasts.
For professional investors, not being all in during a bull market is a career-risking move. But Barnes also notes the familiar observation that most people feel the pain of a loss of $100 more acutely than the pleasure of a $100 gain. “Only people who have been around for a long time are aware that bad things can happen. That explains why old geezers are more conservative,” he says somewhat ruefully.
It’s also been observed that there are bold pilots, and there are old pilots, but there aren’t any old, bold pilots. The same may be said of investors.
Write to Randall W. Forsyth at [email protected]
