Stocks took a hit Tuesday after disappointing economic data showed consumer spending fell more than economists anticipated last month, prompting fears that recently spiking inflation coupled with the delta variant’s spread could lead to a period of stagflation—an uncommon scenario that’s fueled broad market sell-offs in the past and is characterized by stagnant economic growth and prolonged inflation.
After closing at a record high Monday, the Dow Jones Industrial Average fell 490 points, or 1.4%, to 35,135 on Tuesday afternoon after the Census Bureau reported consumer spending fell 1.1% from June to July as online spending and car purchases slowed more than expected.
“This is what stagflation looks like,” money manager Tom Essaye, founder of Sevens Reporter Research, wrote in a Tuesday note, pointing to consumer confidence levels that “shockingly” hit their lowest level in a decade last week as a reminder of the “real risk” the economic recovery slows meaningfully due to the pandemic’s resurgence in the United States.
In another warning sign of stagflation, Essaye says the New York Fed’s Empire Manufacturing Index “offered a similar take on the economy” on Monday, showing a sharper than expected decline in manufacturing activity last month while prices paid by consumers actually rose.
Though he insists stagflation, which sparked a decade of lackluster stock returns in the 1970s, has not yet arrived, Essaye cautioned “the risks are out there” and said that if the trend continues in the government’s August inflation and economic growth readings, “the market will not respond well.”
In a Monday note to clients, JPMorgan warned markets have started to price in a “very pessimistic growth scenario” alongside inflation over the next year, suggesting a period of stagflation could arise even though the investment bank says the scenario is “unlikely” because it believes growth concerns emanating from the delta variant are “overstated.”
Like JPMorgan, other market experts believe the delta variant will have only modest effects on the economic recovery: Marc Zabicki, LPL Financial’s research director, says “slower growth isn’t necessarily a bad thing and tends to keep inflation at bay,” reiterating expectations that prices will moderate by next year once pandemic bottlenecks and materials shortages subside.
“Stagflation is essentially one of the worst economic environments possible, and historically it’s been negative for stocks broadly and bonds” Essaye said Tuesday, adding that only a few sectors, including agricultural commodities (like grains and livestock) and consumer staples (such as food and household products) have been able to weather it in the past.
Stagflation is often associated with lackluster economic growth and runaway inflation—largely driven by “sky-high” energy prices—in the 1970s, Zabicki wrote in a Friday note. That decade, yearly inflation averaged 7.4% (compared to 5.4% in July), and the S&P averaged a meager return of less than 2%. LPL expects lower unemployment will fuel economic growth over the next year, which Zabicki says “should put an end to the stagflation fears that have been bubbling up recently.”
Despite the broader market’s record highs, inflationary concerns have hit the tech-heavy Nasdaq particularly hard in recent months. Though it surged nearly 43% in 2020, the index is up only 15% this year. Meanwhile, the S&P is up 20%, after climbing only 18% last year.