Economic Forecast: Strategists Signal Potential for ’70s Stagflation Replay

Equities faced difficulties while bonds excelled during the turbulent inflationary periods of the 1970s.

Presently, investors are drawn to the idea of a “Goldilocks” market, but a group of quantitative strategists from Wall Street warns of a potential return to conditions reminiscent of the disco era.

In a recent communication, J.P. Morgan analysts, spearheaded by the well-known strategist Marko Kolanovic, cautioned about a possible shift in market sentiment away from the current narrative of Goldilocks toward a scenario similar to the stagflation experienced in the 1970s, which could have significant consequences for asset allocation.

The 1970s were marked by persistent high inflation, characterized by three distinct waves linked to geopolitical events such as the Vietnam War and conflicts in the Middle East. These events, combined with escalating government deficits, created an environment where equities saw minimal nominal gains from 1967 to 1980, while bonds and credit instruments significantly outperformed.

Drawing parallels between the geopolitical landscape of the 1970s and current tensions in regions like Eastern Europe, the Middle East, and the South China Sea, the analysts pointed to recent energy crises and shipping disruptions in the Red Sea as potential indicators of historical parallels.

The analysts cautioned that the escalation of tensions, particularly with China, could exacerbate inflationary pressures and trigger a market downturn. Additionally, they noted that fiscal deficits are unsustainable, raising concerns about the potential shift in the macroeconomic backdrop from the peace dividend era of the late 1980s to 2000s to a period characterized by conflict-driven inflation.

In such a scenario, investors would likely favor fixed-income assets over equities, seeking higher yields to offset the effects of stagflation. Historically, during the 1970s, bonds significantly outperformed equities, with yields averaging above 7%, making any yield pickup crucial for long-term portfolio performance.

Despite these warnings, current market trends show stocks rallying into 2024, with major indices reaching new milestones. However, investors remain cautious, as evidenced by their reaction to the Federal Reserve’s policy meeting minutes, indicating a readiness to reassess market dynamics in light of evolving economic conditions.