Monday, July 17, 2006

Should we be afraid of Stagflation?

To the laymen, stagflation is what happens when you have little economic growth but a good bit of inflation. If that sounds a bit too vague, it is because there is no specific definition of stagflation, unlike recession or inflation. An article by Ticker Sense, a blog affiliated to Birinyi Associates, entitled "The Implications of Stagflation" has attempted to define what's stagflation; and to look at how long it normally lasts as well as how much it impacts the stock markets.

They define stagflation as "any period of two quarters or more in which y/y CPI was above the overall average since 1948 and y/y GDP growth was below its overall average since 1948".

The average stagflation lasts about 8 quarters with the shortest lasting about 4 quarters. To measure stock performance, the stagflationary period is divided into 2 halves. During the first half of a stagflationary period, stock performance is generally negative (-11%) while performance in the second half is generally positive, with an average gain of 21% (see the Chart).














The article, however, did not provide any statistics on the stock performance prior to the stagflationary period. The stock market, being a leading indicator, would have adjusted easily 2 or 3 quarters before stagflation set in. If we were to factor in the loss incurred prior to the stagflationary period, the overall loss would likely to exceed 11% and possibly surpassing the average gain of 21% recorded during the second half of the stagflationary period. Otherwise, why should investors fear stagflation?

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