Many economists were predicting a return to the Roaring Twenties at the start of 2022: Businesses would resume full operations and consumers would spend their accumulated savings, much like what happened after the 1918 influenza pandemic.

Yet the first six months of 2022 have been anything but “roaring.” COVID-related supply chain shutdowns in China, the Russian invasion of Ukraine and higher-than-expected inflation rates have caused economic growth forecasts to deteriorate. The Federal Reserve is in the process of raising rates to combat inflation, but if it is unable to soft-land the economy, it may force the country into a recession. We could see elevated prices, and at the same time, a slowed economy. This is known as stagflation.

What is stagflation?

Stagflation occurs when high inflation and slow economic growth (the decline in gross domestic product or GDP) occur at the same time. High unemployment is often a factor with stagflation, as well. Businesses respond to decreasing growth by cutting costs and laying off employees, which in turn pushes unemployment rates to higher levels. The possible loss of income increases with rising unemployment, and those households that manage to keep their jobs see their purchasing power eroded by higher inflation. This is what we experienced in the 1970s.

What happened in the 1970s?

The 1970s was a time of unprecedented poor policy decisions by the Federal Reserve. These policy decisions exacerbated rising inflation and geopolitical events, causing a major shock for oil and economic growth. For example, the oil embargo by OPEC in 1973 caused the global price of oil to rise dramatically, leading the cost of goods to increase and unemployment to rise as well. The 1970s also saw increased regulation of markets, goods and labor. Union membership was significantly higher in the 1970s, contributing to increased labor costs. Inflation hit double digits and interest rates climbed rapidly, rising to nearly 20% in the early ’80s.

How does this differ from today?

Over the past two years, the government has spent huge sums of money through multiple rounds of stimulus payments while the Fed has kept interest rates low to jumpstart the economy. The economy is still doing well: Corporate earnings are strong; unemployment is near record lows; and signs that inflation is peaking are starting to show. While GDP did contract 1.5% in the first quarter of 2022, the weakness was not the result of a fundamental slowdown in economic activity. Rather, we saw businesses stockpile inventory due to supply chain shortages in the fourth quarter of 2021, and in the first quarter of 2022 we saw a reversal as consumers ate away at inventory levels. Today, we are significantly less dependent on foreign oil compared to 50 years ago. Higher oil prices overseas do not play as significant a role as they did in the ’70s and ’80s. Also, we have a growing number of electric vehicles and cars are much more fuel efficient, getting three times more miles to the gallon than in the ’70s.

While mortgage rates in the ’80s hit 15%, the average home price was $73,000. The mortgage payment, adjusted for inflation, would have been $3,400 per month today. With current mortgage rates at 5% (up from 3% at the start of the year) and the average home price at $400,000, the average mortgage payment today is $2,400. This is still $1,000 less per month compared to rates in 1970s, when adjusted for inflation.

A large degree of uncertainty remains, and the potential threat of stagflation is real. The Russian invasion of Ukraine and COVID lockdowns in China threaten to further disrupt the global supply chain, negatively impact energy prices and interfere with economies around the world. While inflation has shown some signs of waning, it is still not under control in the U.S. and overseas. Yet slower economic growth is still a more likely scenario than stagflation. Hopefully, the Federal Reserve’s leadership has learned much from the policy mistakes in the 1970s.

How can you combat stagflation?

First and foremost, as we repeat each week, it is not wise to panic and sell out of the market. Instead, continue to focus on the fundamentals of savings and diversification. During times of recession or stagflation, prioritize your spending and saving to align with your financial goals. It also may make sense to delay expensive purchases. Consider using excess money to pay down debt, build up an emergency fund or dollar-cost average into your portfolio. Few economists agree on how to stop stagflation once it has started, meaning it may cause long-term pain to businesses and middle-class and lower-wage households.

So, what can we learn from all this? History tends to repeat itself, but the story may be a bit different each time. There are several differences between the 1970s and today, and even though stagflation is a possibility, that doesn’t mean it will result in a 10-year period of double recessions and super-high inflation. It is always difficult to see the value of your investments fall. 

During these challenging times, it is important to keep the following in mind: 

• Ignore the noise and sensationalist headlines.
• Remember that selling into a panic is not an investment strategy.
• Market declines are a part of economic cycles.
• Don’t try to time the market. Instead invest regularly, even when the market is falling.

It is likely that this recent market drop may be a mere blip in the long-term investment plan. We do not try to time the market. What really matters is time in the market, not out of the market. That means staying the course and continuing to invest, even when the markets dip to take advantage of potential market upturns. We continue to adhere to the tried-and-true disciplines of diversification, periodic rebalancing and looking forward, while not making investment decisions based on where we have been.

Investing is about following a disciplined process over time.

At the end of the day, investors will be well-served to remove emotion from their investment decisions and remember that over time, markets tend to rise. During volatile markets, it’s important to remember that the fear of losing money is stronger than the joy of making money. Investor emotions can have a big impact on retirement outcomes. Market corrections are normal; nothing goes up in a straight line. Making market decisions based on what might happen may be detrimental to long-term performance. The key is to stay invested and stick with the financial plan. Markets go up and down over time, and downturns present opportunities to purchase stocks at a lower value.

It all starts with a solid financial plan for the long run that understands the level of risk that is acceptable for each client.  Regarding investments, we believe in diversification and having different asset classes that allow you to stay invested. The best option is to stick with a broadly diversified portfolio that can help you to achieve your own specific financial goals — regardless of market volatility. Long-term fundamentals are what matter.

Sources:  Financial Times, Investopedia, Kestra Investment Management, Time

This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.

Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.

Past performance is not a guarantee of future results.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

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