The market resumed it’s downward plunge on Wednesday as things are just getting downright nasty over in Greece with riots now plaguing the country. As bad as that is, I think an even scarier domestic situation is making its way into investors’ minds. It’s a no-win situation that is terribly toxic for everybody. Is it time to fear stagflation?
Stagflation Defined
For those that don’t know, stagflation is the combination of a stalled or shrinking economy combined with inflation. Generally prices fall during recessions but occasionally they don’t when an external shock such as an oil price surge occurs at the same time. We are possibly entering one of those times when commodity prices are sky high and the economy is weak simultaneously.
Hot CPI
Core inflation jumped 0.3% in May, which was the biggest jump since July 2008. Headline inflation is running at a 3.6% annualized rate, which is certainly higher than the Fed would like. At the same time, we got word that the Empire Manufacturing Report came in at -7.79, which was the first negative reading since last November. This isn’t a widely followed survey, but it’s another disappointing economic report in a long line of sour ones.
I think we are getting the unwanted consequences of the Fed’s QE2 program here. Its main effect was to cause a huge rise in commodities and risky assets, which raised the price level, but didn’t do much good in terms of spurring consumer demand.
Bernanke stated that it was his aim to juice asset prices with the hopes that the wealth effect would help the consumer spend more. The first part surely happened, but I think the nasty combo of stagflation might be the unpleasant after taste.
What It Means
It is clear that a quicker pace of inflation is here to stay, but the jury is out about the nature and duration of this economic weakness. We all hope it is only a “soft patch,” but if it turns out to be another recession, then stocks have much further to fall. This time however, it is unlikely that a QE3 will come to the market’s rescue. It’s time to let market forces play out because we are getting some nasty side effects from the medicine that was supposed to cure.
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