After two years of surging inflation, are we going back to goldilocks?
Investors loved the low inflation environments of the 1990s and 2010s, which delivered huge returns for equities, but they haven’t enjoyed the post-pandemic stock gains as much. Stocks fell sharply in 2022 and although they rebounded last year, they haven’t passed their old highs.
The goldilocks economy of the 1990s and the 2010s had two key characteristics: low inflation and steady growth. The good news for equity investors is that inflation is falling worldwide.. In the past six months U.S. core inflation has run at an annualized pace of below 3%, and outside of rental costs it’s below 2%.
So, the inflation front is improving. However, the economic growth front may be looking shaky. 5.25% of Fed rate hikes, along with similar rate hikes from most of the world’s other central banks, could take its toll on economic growth in 2024. If the economy falls into a recession, that could be bad news for stocks. The S&P 500 lost 50% of its value during the 2001 recession and 60% of its value during the global financial crisis even as inflation rates remained low.
Additionally, stocks were cheap in the early 1990s and the early 2010s when the S&P 500’s market cap was worth about 50% of annual U.S. GDP. Now the S&P 500 is trading at close to 160% of U.S. GDP. As such, even if it returned to a goldilocks economy, it’s not obvious that stocks would perform exceptionally well.
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