How today's economic backdrop evokes déjà vu of past decades

AGF CEO and chief investment officer says inflation and other indicators could prompt a replay of previous significant periods

How today's economic backdrop evokes déjà vu of past decades

Following the September turbulence in equity markets, last month saw the S&P 500 stage a rebound with a 9% advance amid a third-quarter earnings season of small wins in key sectors. Aside from banks and tech giants, investors in the U.S. stock market witnessed optimism among industrial firms that were more exposed to supply chain disruptions, suggesting better days could be coming.

Still, there are plenty of reasons for concern. In a recent commentary, AGF Investments CEO and Chief Investment Officer Kevin McCreadie noted that investors should anticipate more muted gains in the last two months of 2021, as well as more pronounced concerns around inflation and the potential for rate hikes as a result.

“[Recently], the Bank of Canada suggested an increase in its key lending rate would come sooner than originally expected given the persistence of higher prices,” McCreadie said. “Moreover, the market seems to be pricing in as many as five rate increases by the end of next year.”

The Federal Reserve has also signalled that it would soon begin paring back on its bond-buying, a decision that could only be reinforced after official figures showed the U.S. hitting a thirty-year high in inflation. With speculation on when the Fed will raise its key lending rate growing more rampant, he said, U.S. stocks are facing increased risks of facing major economic headwinds.

McCreadie also pointed to the fact that the U.S. economy softened during the third quarter, partly due to the COVID-19 delta variant’s dampening effect on economic activity across many countries in the summer. While the new strain’s impact is waning, so is the pace of government stimulus, clouding any outlook of meaningfully higher interest rates in 2022.

Also weighing on the growth outlook is China, which is still struggling with concerns related to energy and material shortages. “[T]he combination of its zero-tolerance policy on Covid-19 and heavy-handed regulatory stance runs the risk of negatively impacting growth further in the near term,” he said.

The current state of play for investors, McCreadie said, is reminiscent of the 1990s when modest inflation of 3% pushed interest rates and bond yields higher, but not to the extent that they undermined stock markets. From trading a little above 300 points at the beginning of 1990, he said the S&P 500 climbed to well above 1,000 points by the beginning of the new millennium.

While that run was punctuated by excessive speculation leading to the early-2000s tech wreck, it showed how stock markets could navigate well through moderate inflation and a measured tightening of monetary policy. Of course, things could just as easily turn for the worse.

“What investors don’t want to have happen again, however, is a repeat of the 1970s, when commodity prices climbed dramatically, the economy sputtered, and stagflation took hold,” McCreadie said. “[I]f energy prices continue to rise like they have of late, it could have a negative impact on consumer spending and the trajectory of the economy. In this environment, commodity stocks may still do well, and defensives like consumer staples and utilities may benefit, but it’s a tough slog otherwise and not a great environment for investors.”