A 1970s Wage-Price Spiral and Stagflation Scenario Keeps Percolating

This Week's Market Rap

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Hi.  Peter Navarro here with this week’s market wrap for the very first week of 2024.

Let’s start with the two most important observations of last week’s market rap.   First, I indicated that last week’s market movements would not really matter much in terms of information about the market trend.   The likely bullish or bearish trajectory of the market in 2024 might be revealed this week as the first week after the new year is often a harbinger of the year to come.

Here, it is worth noting that, going back to 1950, . When stocks finish the first week of the new year higher, the S&P 500 has been positive 82% of the time at year-end with an average gain of 13.6% -- this according to Stock Trader’s Almanac. 

If that statistical past is prologue, the outlook for 2024 may not be good.  Stocks tanked on the first trading day and finished down for the week. 

Second, I told you that more than 90 percent of the 2023 gains for the S&P 500 were the result of only 20 tech stocks and mostly the so-called “magnificent seven” of Apple, Amazon, Google, Tesla, Facebook-META, Nvidia, and Microsoft.  The clear implication of this finding is that there is much more uncertainty lurking below the surface of the rest of the American non-tech economy and this is evident in a comparison of two charts.

The first chart – podcasters, please visit peternavarro.substack.com for the chart -- is that of the S&P 500, as measured by the Exchange Traded Fund SPY, for 2023.  You can see it as a bit of roller coaster but one that takes a sharp move up, beginning at the end of October for a total return of about 25%.

In contrast, the second chart is that of the exchange traded fund SPYX, which is the S&P 500 without tech.  In this case the annual gain was cut roughly in half at about 12% -- still decent but hardly overwhelming.  Again podcaster audience, go to peternavarro.substack.com for transcript and chart.

Manufacturing Remains in Trouble

A third chart I want to bring to your attention is that of the ISM manufacturing index.  It is a diffusion index measuring from 0 to 100 and any reading under 50 indicates the manufacturing sector is under contraction.

Historically, this has always been one of my favorite economic indicators, and the latest printout from last Tuesday has the ISM Manufacturing Index at 47.4, well below the magic 50 for the fourteenth month in a road.  Troublesome to say the least.

Biden’s Wage-Price Spiral

Okay, let’s cut to another chase.  From previous missives, you may recall my concern of a wage-price spiral that may well trigger a longer term stagflation scenario a la the 1970s.  This concern is historically based:

The decade long 1970s stagflation – simultaneous inflation and recession -- began in the late 1960s with pure, unadulterated demand pull inflation when President Johnson refused to cut butter as he increased the guns portion of the budget for the Vietnam War. 

Then, in 1973 and 1974, the US was hit with a double tap of cost-push inflationary pulses in the form of spiking oil and food prices.  Oil prices – and gas lines! -- spiked with the Arab oil embargos and food spiked because of an El Nino condition that disrupted the supply chain for animal feeds.

The resultant one-two punch of demand-pull and cost-push inflation then forced President Nixon to abandon the gold standard in favor of letting the dollar float.  With that float, the dollar actually sunk like a stone by double digits and created even more inflation by driving up the cost of imports.

Predictably, the Federal Reserve struck back at the inflation with rate hikes but it didn’t keep the pedal to the metal long enough.  Instead, it reversed course as recession and stagnation took hold, paving the way for an ensuing wage-price spiral.

This virulent wage-price spiral showed up as the inflationary expectations of consumers and workers led to rising wage demands and would not abate until the Draconian tight money policies of Ronald Reagan’s new Fed chair Paul Volcker in the early 1980s.

The 1970s parallels to our current situation are striking.  Biden is provoking a demand-pull inflation with profligate spending even more dangerous than LBJ’s guns and butter orgy.  All manner of cost-push supply shocks continue to rain down on our oil and food markets – war, bad weather, supply chain disruptions.  And we come now to Friday’s news which indicates that there is indeed an incipient and potentially highly toxic wage-price spiral in its early stages.

As a sidenote, let’s not here in Trump’s America forget that the entire Biden strategy to control inflation focuses on destroying the purchasing power of middle and lower income Americans by putting downward pressure on real wages – nominal wages minus inflation.  This is the ENTIRE thrust of Fed interest rate policy, that is, choke down the economy to below potential output without inflation and through slower growth choke down wages of the Deplorables in Trump’s America.

Of course a far better, and far more Trumpian, strategy would be for Biden to cut spending, fix our supply chains, and soothe the geopolitical landscape – but don’t hold your breath.

So it is that we learned on Friday that payrolls remain robust, wages continue to rise significantly, and Friday’s jobs report made it clear to Wall Street that the assumed set of rate cuts by the Fed in 2024 that has been fueling a bullish rally may very well not happen.  Indeed, these rate cuts may not happen for a long time – as the legendary Dennis Gartman has put it, “high for longer” is the most likely scenario.

Here, you might say “Navarro, so where’s the stag part of the stagflation come in if the unemployment rate is holding and growth appears to be above expectations.  Well, as in the 1970s, it took a few years for the wage-price spiral and stagflation to really take root.

Here, the shoots of stagflation may be teased out of Friday’s jobs report.  While that report indicated continued strong job creation, everything else was bearish: We saw the largest drop in household employment since April 2020, more people taking part-time work for economic reasons, a spike in the duration of unemployment spells, a falling labor force participation rate, more temp workers unable to find jobs, and a decline in working hours.

The last thing to note here is that we should not conflate deflation with a lowering of the inflation rate.  Talking head CNBC anchors aside, inflation has not gone into a reverse deflation scenario. 

Au contraire.  Prices continue to rise but at a slowing rate.  Meanwhile, past price hikes have been now baked into the system AND the percentage price hikes we are seeing are based on the new higher bases.  Meanwhile, the stuff that we deplorables in Trump’s America really care about like meat and vegetables continue to rise uncomfortably.

Alright, that’s it for this week.  A low risk strategy now is cash parked in two-year bonds until the market smoke once again clears.  Risk is to the downside but it’s too early for a short.  Bon chance.