Inflation has long been a critical factor influencing economic conditions and stock market performance. The 1970s serve as a stark reminder of the potential devastation inflation can bring, with three significant waves leading to severe market downturns. Today, echoes of the past are resurfacing as we grapple with inflationary pressures once again. This article explores historical lessons and current indicators to provide insights into what lies ahead for the stock market.
Inflation in the 1970s VS Today
The 1970s were marked by three catastrophic waves of inflation in the United States, each wreaking havoc on the stock market. Over a decade, the market plummeted by a staggering 70% on an inflation-adjusted basis. These events serve as a crucial case study for understanding the impact of prolonged inflationary periods.
Fast forward to today, and we have experienced the largest wave of inflation since the 1970s, which caused the market to drop by 25% in 2022. Many economists argue that this might be just the beginning, with the Consumer Price Index potentially following a similar trajectory as it did in the 1970s.
Former Treasury Secretary Larry Summers has repeatedly cautioned about a second wave of inflation, citing high levels of government and deficit spending as major contributing factors. The big question is whether we are currently witnessing signs of this second wave and how it might impact the stock market.
Super Core Inflation: A Mixed Signal
Super core inflation, which excludes volatile food and energy prices along with shelter, indicated a significant uptick in early 2024, reminiscent of the 1970s. However, this metric has since shown a notable cooling, suggesting that a sustained second wave of inflation might not be imminent. Yet, the risk remains, as inflation dynamics can shift rapidly.
To fully understand inflation trends, it’s crucial to consider metrics that include energy, food, and shelter prices. These components are significant drivers of overall inflation. Rising food and energy costs, for example, can quickly translate into higher prices for a wide range of goods and services, impacting businesses and consumers alike.
Energy and Food Inflation
Gasoline prices at US pumps have been on a steady decline since June 2022, showing no clear signs of a second inflation wave. Although there has been a slight increase since January 2024, crude oil prices have dropped over the last three months, which could help keep gasoline prices in check.
Food inflation is currently at 2%, a reasonable level compared to the past 20 years. This is a significant improvement from just two years ago when food inflation was at 11%. Presently, there are no indications that food inflation is picking back up, which is a positive sign.
The Stock Market’s Relationship with Inflation
The stock market is profoundly influenced by inflation due to the Federal Reserve’s actions. For example, in early 2021, despite high inflation, the market continued to rise until the Fed began discussing rate hikes. When the Fed started raising rates, the market dropped by 25%. Even after inflation peaked in June 2022, the market continued to decline until the Fed considered pausing rate hikes.
The Federal Reserve’s Role
The Federal Reserve has maintained interest rates just above 5% since August 2023. Each mention of potential rate cuts has propelled the stock market higher. This trend suggests a high likelihood of further market gains if rate cuts occur.
In its last meeting, the Fed, led by Jerome Powell, took a more hawkish stance, citing stubborn inflation as a reason not to cut rates yet. Despite this, the S&P 500 surged following the meeting, although underlying market realities may differ.
S&P 500 Equal-Weighted Index
The equal-weighted version of the S&P 500, $RSP, which balances out the influence of major stocks like Nvidia, Microsoft, and Apple, has been trending down recently. This divergence could signal potential market corrections or a lagging setup that might catch up and lead to another rally.
Core inflation in the United States is at one of its lowest levels in the past four years, lower than in June 2023 when the Fed paused rate hikes. This could prompt the Fed to cut rates more aggressively than currently anticipated, potentially driving the market higher for a final push.
Conclusion
The lessons from the 1970s remind us of the severe impact inflation can have on the stock market. While current inflationary pressures have shown signs of cooling, the potential for a second wave remains. The Federal Reserve’s actions will be crucial in determining the market’s future direction. By closely monitoring comprehensive inflation metrics and the Fed’s policy moves, investors can better navigate the complex economic landscape ahead. Click here to sign up! Subscribe to our YouTube channel and Follow us on Twitter for more updates!
