Stagflation vs. Growthflation
Stagflation is one of the ugliest words in finance because it conjoins two ugly economic words with opposite meanings.
A ‘stagnant’ economy is one with little or no growth. US economic growth - as measured by the ubiquitous GDP - is so far looking less strong under the Make America Great banner compared to what we had during Sleepy Joe Biden. And what’s worse is that numerous economic metrics point to even slower growth down the road. I’m talking about things like consumer debt levels, unemployment numbers and housing sales. I discussed these dour economic metrics in last week’s newsletter so there’s no need to repeat them here.
But what about ‘inflation,’ which is the opposite of stagnancy. Inflation is all about increase, but tragically it is price levels which are going higher, currently averaging about 3% growth a year, from earlier 2.5% levels. (Inflation was averaging about 2%/year throughout last decade.) And, yikes, the full inflationary effects of tariffs have yet to fully kick in, not to mention the full inflationary effects of fewer foreign-born workers out in the labor force, helping to bring products to market.
2. GROWTH-FLATION
This is a big problem, both in the markets and the broader economy. Yes, America (and much of the world) experienced surging inflation during the post-Covid years, at one point reaching 9% inflation growth in 2022. But, post-Covid, America was also experiencing economic growth and sky-high employment, including wage growth of about 5%. I call this “growth-flation.” To be sure, a 5% increase in wages couldn’t compensate for a 9% increase in price levels in 2022, but as inflation moderated in 2023 and ‘24 - and employment/wages remained high - America was looking great again. This dynamic partly explains why the S&P 500 surged over 20% during each of those 2 years, a back-to-back feat that’s only happened once before - during the Clinton years.
3. WILL WE SEE STAG-FLATION?
But here we are in 2025 and the broad economy seems to be slowing, but prices are rising, an ominous sign. Investors are overlooking these negatives because the market is mesmerized by the sizzling artificial intelligence sector which is consuming everything in its path. Nvidia, for example, has become so big that its size is equal to 3.6% of GDP, not of California, nor of America, but of the globe. Nvidia is bigger than the entire market of all but 3 countries in the world. Wow. Stocks like Nvidia are why a broad stock index like the S&P 500 continues to trudge higher, rallying 1.52% on Friday, helping it squeak out yet another weekly gain. The S&P is now 9.95% higher for 2025, a stunning turnaround from the April lows. I predicted in my January yearly newsletter that the S&P 500 would return 10.65% for 2025 but we’re already almost there, which strengthens my conviction that we’re due for a modest September/October equity pull back before ending the year strong. September is one of the weakest historical months for the market so don’t expect much in the market next month, in my opinion.
Why do I write, “don’t expect much next month?” Because the reason why the market surged this Friday isn’t because of solid economic fundamentals, but because Jerome Powell gave MAGA what it craves: the promise of more sugar. In this case, I’m talking about the assurance of lower interest rates. Mr. Powell stated that job growth is slowing (that’s bad), but that prices are rising (that’s worse) a classic stagflationary setup. Nonetheless, Powell also stated that “the shifting balance of risks may warrant”…a rate cut. As the venerable Barron’s magazine writes this weekend, the US stock market party is like “an overflowing punchbowl, which the Fed apparently is ready to spike with more hooch.”
Rate cuts give fuel to the fire of the stock market and real estate market, making the rich much richer. But if job growth continues to slow, sapped of its strength by tariffs and the job-sucking power of Artificial Intelligence, then stagflation may rule the day making rate cuts more dangerous. America is about to see a Trumpian wave of rate cuts – I predict we will see 300 basis points of cuts (ie. 3%) from today till the end of next summer. This is a gamble on the entire US economy. This whole situation explains what I’ve been saying the entire year: the markets will likely have a good 2025, but I remain concerned about next year, 2026 – which I think will be a negative return year for the markets.