With dire warnings from blue chip financial leaders indicating we are heading for an economic and market hurricane, it’s time to sit up and take notice. With record inflation numbers driven by wage-price pressures not seen since the 1970s, we need to analyze that inflation cycle and what happened to markets. Buckle up folks because it is not pretty!
Historic Inflation Cycles and Markets
After the end of World War II, the U.S. entered a period of Goldilocks economic growth and prosperity. Market indexes soared in what became known as “Happy Days”. But the growth engine and low inflationary environment started to turn by 1965 into an overheated inflation bubble driven first by wage-price inflation and then by the 1973 oil embargo. The price of oil jumped fourfold and shocked the U.S. economy. The country was in the grips of “Stagflation”, a period of high inflation with an emerging recession.
With a 6.23% average inflation rate over this 15-year period, it’s no wonder investment markets suffered one of the worst performance periods on record. From 1965-1979, the S&P 500 index generated an average rate of return of just 1.12% per year for a cumulative price change of 16.78%. Each time inflation spiked, the market took a nose dive. During this period, the market posted three bear markets (-20% or more from the market high) and came close a fourth time.
The reason we are walking down memory lane is to help investors understand what is likely ahead for markets. The cause of inflation in the 60s-70s was somewhat different than what we are experiencing today. Yet the outcome is strikingly similar — wage-price inflation with an adverse energy price cycle with oil price spiking by almost 400%.
With this backdrop, the markets are going to struggle to produce positive returns until the Fed can break the back of the current wage and price spiral. So far this year, the markets are off to a bad start and inflation is not abating. The Fed is just starting their war on inflation and investors should beware. Note that the bear market cycle, shown in the chart above, lasted a very long time and consisted of some powerful bear market rallies that seduced investors into reinvesting (taking on more risk), only to end up losing more capital.
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Unless otherwise indicated, source of all data is Bloomberg, 2022.