Powell Isn't Buying the 'Stagflation' Story

The dreaded 'S' word has officially entered the economic spotlight...

Earlier this week, the U.S. Bureau of Labor Statistics released its inflation report for April. While the numbers show something of a cooldown, consumer prices still rose 3.4% year over year.

That's the 11th consecutive month of inflation around 3%.

To make matters worse, economic growth is slowing. U.S. gross domestic product ("GDP") grew 1.6% in the first quarter... down from 3.4% growth at the end of last year.

Now, economic experts and media pundits alike are touting "stagflation." They fear the Federal Reserve's lack of progress may be sending the economy into a 1970s-style scenario.

However, at the central bank's meeting earlier this month, Chairman Jerome Powell said he didn't see the "stag" or the "flation"...

Powell warned that there hadn't been much progress toward cooling the economy since the Fed's last meeting. Employment is still strong. And inflation isn't getting much closer to the 2% target. As a result, the Fed decided to hold interest rates steady.

That said, Powell made it clear that stagflation isn't the issue. He insisted that growth has remained stronger than everyone thinks.

He said the slightly lower data points aren't actually bad at all... and we agree.

The last time the U.S. saw stagflation was in the 1970s...

The term refers to a period of high inflation, high unemployment, and low economic growth.

Back in the 1970s, inflation was in the high single digits and economic growth was much weaker. At one point, the annual unemployment rate topped 8%.

The entire period was known as the "decade of inflation." And the average inflation rate was nearly 7%.

That's more than double what it is today.

Plus, as we said earlier, employment remains strong... The unemployment rate sits at 3.9%.

Even though GDP growth came in at 1.6% in the first quarter, that's referring to real GDP. That means the figure is adjusted for inflation. And we don't expect that weak economic growth to last for long...

The U.S. is investing heavily in different sectors of the economy that will help boost growth.

Artificial intelligence continues to be one such area... Its market is expected to exceed $1.8 trillion by 2030.

And semiconductor and infrastructure companies have received billions of dollars in federal funding. That's slowly starting to translate into economic growth.

Of course, it's possible that with this growth comes more inflation... But because the Fed is holding firm on interest rates, we don't see a scenario where inflation rises back to what it was in the 1970s.

Like Powell, we don't see the stagflation that many folks are worried about. We think the Fed is actually doing a good job of making sure inflation stays under control.

The economy seems like it's heading to 'just right' levels...

In other words, it's a "Goldilocks" economy. It's not too hot, and it's not too cold.

Inflation is stickier because of our healthy growth. And as long as inflation stays around where it has been and GDP starts to rebound – without getting too hot – we aren't heading for stagflation.

That's not to say all is well today. There are pockets of the economy that aren't as strong as others...

For example, with stickier inflation, folks have tightened their purse strings. That has weighed on consumer staples.

Yet as we touched on earlier, that's not the case for every industry. Infrastructure and chipmaking companies are seeing growth.

Overall, the economy is still strong... The Fed is just making sure that it doesn't run hot enough to spur record-high inflation again.

While economists may be worried, this is the exact type of economy that can drive the stock market higher.

Regards,

Joel Litman
May 20, 2024