Today, inflation is one of the world’s most urgent economic problems. Rising prices have dramatically reduced the wealth and purchasing power of large swathes of the developed world.
While inflation is certainly a major driver of economic crisis, there’s a greater danger around the corner: stagflation.
Market effects of Stagflation
The term “stagflation” was first used in 1965. It refers to an economic cycle that has a high inflation rate and high unemployment, along with low demand. This term was first used in 1970s when the United States entered into an extended oil crisis.
Stagflation has been a constant occurrence in developed countries since the 1970s. Many analysts and economists believe the U.S. will enter a period in which inflation and rising unemployment rates are more difficult to manage.
Real rates, which are inflation-adjusted interest rates, can help you measure stagflation. Real rates show the real yield and the real returns on assets. This reveals the true direction of the economy.
According to the U.S. Bureau of Labor Statistics (USBLS), the July consumer price index (CPI), recorded an inflation rate of 8.5%. Many policymakers dismissed the severity of the current inflation rate by allowing the July CPI to show a 1.3% increase over its May numbers.
Real rates however paint a very different picture.
Current 10-year U.S. Treasury yield is 2.8%. The real yield of U.S. Treasury bills with inflation at 8.5% is 5.7%.
The global bond market size is approximately $119 trillion as of 2021. The Securities Industry and Financial Markets Association, (SIFMA) estimates that $46 trillion comes from the U.S. All fixed-income market SFIMA tracks (e.g. mortgage-backed securities, corporate bonds, municipal securities and asset-backed security (ABS), have negative returns adjusted for inflation.
The S&P 500 index is also included in this category. The S&P 500 index is in the highly overvalued Shiller price/earnings ratio (P/E). This ratio measures the performance of the stock market by displaying the S&P index’s inflation-adjusted earnings over the past 10 years. The current Shiller P/E ratio 32.26 is significantly higher than those recorded before 2008’s financial crisis and is comparable to the Great Depression of the late 1920s.
Graph showing the Shiller PE ratio between 1880 and 2022. The real estate market is also struggling. The global real estate market’s value reached $326.5 trillion in 2020. This is a 5.5% increase over its 2019 value, and a new record.
This year, the number of people expected to move up was due to an increasing population. Since 2008, the U.S. has had interest rates close to zero, which has made mortgages affordable and increased housing sales.
This is likely to change with the recent rise in interest rates that we have seen since the start of the year. The National Association of Home Builders (NAHB), housing market index, saw its fastest decline of -35 in history starting in January. This index fell faster than it did in 2008, when the housing bubble burst. This was also the longest monthly decline that the NAHB index has ever seen. August was the 8th consecutive month of decline since 2007.
Graph of the U.S. NAHB Housing Market Index, 2001-2022. With almost all segments of the market experiencing declines, it is possible that many institutions and asset managers will be rethinking their portfolios. The stagflationary period could last several years and includes overvalued real yield bonds, negative real yield bonds, and overbought equities.
Hedge funds, asset managers, large institutions and asset managers could be faced with a difficult choice: either stay in the market and weather the storm and take short- and long-term losses or rebalance their portfolios to diversify assets that are more likely to grow in a stagnant market.
Chart showing the market value Institutional adoption of crypto has grown at an unprecedented rate, with other assets becoming an integral part many large investment portfolios.
Bitcoin, however, could be the most popular and liquid crypto asset.
Research: What happens when there is a stagflationary environment for assets? Is it possible for smart money to eventually invest in Bitcoin? CryptoSlate.
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