For example, when a hurricane hits Florida the following typically occurs: businesses shut down; people are unemployed; prices of scarce goods jump.
After a while, a recovery gets underway and employment rebounds and things slowly get back to normal. But the impact tends to be regional in nature, NOT nationwide.
COVID-19 —what we are experiencing with COVID-19 is something the modern world has never seen (government shutting down businesses all over the country for more than a month).
It is a perfect storm of bad economic news: stagnant (slow or declining) economic growth; declining gross national product; high unemployment; rising prices, i.e. inflation.
Stagflation can result in a potentially long period of economic malaise that can impact long-term investment returns and return expectations. The most common cause of stagflation is government policies that disrupt normal market functions.
Prior to March 2020, the U.S. economy was strong with relatively low inflation. In April 2020, the economy shut down except for essential businesses in most states, the stock market fell more than 35%, unemployment is out of control, and there is no certain end in sight.
We have a massive government stimulus program, but consumer spending is way down and business shutdowns are expected to persist.
Getting to know stagflation—according to Keynesian theory, a stagnant economy and high inflation should be impossible. In a normal economy, slow growth prevents inflation. Low consumer demand keeps prices from rising.
The 1970s proved the theory to be a fallacy. From 1973 to 1975 the U.S. economy reported five quarters of negative GDP. The U.S. stock market lost 50% in 20 months and investors took nearly a decade to recover their losses.
Stagflation started in the 1970s with OPEC cutting oil exports to the U.S. in retaliation for the U.S. decision to resupply the Israeli military. Oil prices quadrupled driving up the costs of consumer goods so fast that wages failed to keep up and a mild recession began.
In response, President Nixon instituted a 90-day freeze on all wages and prices to control inflation and imposed a 10% tariff on imports to protect domestic industries. U.S. companies couldn’t raise prices to remain profitable and couldn’t lower salaries, so they laid-off employees to reduce costs.
The Federal Reserve raised interest rates to fight inflation, lowered them when businesses stopped hiring to fight low employment, then raised them again.
Stagflation lingered until falling oil prices, combined with President Reagan’s focus on supply-side economics, helped the U.S. economy start a recovery in 1983.
Historically, stocks that offered the greatest potential for profit during stagflation were health care, food, and utilities. During the 1970s, commodities including gold, oil, and industrial metals performed well. It was also a good time to invest in world currencies as the U.S. dollar was declining in value. Given the current flight to the U.S. dollar, the opposite is happening today.
Protecting your money in a volatile market—no one has a crystal ball as to what will happen in the stock market in the near future. What we do know is that there are tools you can use to protect your money from downturns in the stock market while still providing some amount of upside gain.
One tool is a Fixed Indexed Annuity (FIA) which has the following features:
- You can never lose money due to downturns in the stock market.
- Gains are locked in annually with most products.
Let’s compare an FIA with a 5.5% annual cap (there are caps on the gains in most products) to the S&P 500 stock index.
- FIA rate of return: 2.96%
- S&P 500 rate of return: -5.66%
The following chart illustrates how money grows in an FIA.