You're listening to Strictly Business Podcast with Lindsay Williams.
With me is John Stockford, Head of Multi-Asset Income at 91 in London.
And the subject matter today is stagflation.
Now, John, I've been in the markets for quite a long time in various forms, and
stagflation seems to come up every couple of years,
but never materializes.
This time, it might be different, because apparently in a random survey, 70% of
market participants
I think there is a threat of stagflation.
Are you one of those 70%?
Well, yes, at the margin.
I guess it depends what we're talking about.
So we are, particularly the US,
we think some of the policies that have been enacted are likely over the next 12
months or so to
depress growth and push inflation up a bit.
But to some extent, it's whether that becomes more persistent, I think, that is
a sort of more difficult question.
Yes, I think that the tariff situation only plays out maybe in three to six
months'
time as the prices filter through to the inflation numbers.
But what we are seeing is inflation not at the CPI level, because that came in, I
think, in the States at 2.7%,
which was better than expected.
But it's elsewhere.
It's in the PMI services sector index.
It's the prices paid in that area.
It's also in PPI, the wholesale prices, which went shooting up recently.
So there is some inflation there and there's a slowdown in the jobs market and
GDP looks a bit vulnerable.
So it's all got the sort of nascent fundamentals for stagflation, I think.
Yeah, I think that's right.
We'd also chuck in what's going on with immigration.
So stopping people entering the country and sending some people back is...
hitting labour supply, which also hits demand,
but leaves the labour market a bit tighter than it might otherwise be.
So there's a whole number of things.
And so we would expect growth to be somewhat negatively impacted.
And you're right, we're at levels on labour market or jobs growth that are,
if they continue to decelerate, I think that would catch the attention of
central bankers and markets to some extent.
I mean, we're close to what you might describe as a trigger point for a much
more negative picture.
That's not really the focus, I think, of the market.
Ironically, you know, people have been talking about stagflation,
but it doesn't seem to bother the equity market at all.
And we can talk about that.
And to some extent, actually, you could argue that the bond market at least
sort of short to medium dated bonds have been behaving fairly, you know, in a
fairly relaxed manner.
So what people are saying and what they're doing are perhaps a little bit different.
It's very interesting you talk about the markets and how they're behaving,
because there was a lovely quote in the Reuters article that piqued my interest in
stagflation.
And it says stagflation is in the mind of the markets, but not in the price.
At some stage, of course, it will manifest itself in the price.
Let's just have a fantasy.
Our fantasy is that there is going to be stagflation.
So we have to work out what goes first, what happens first.
Is it the bond market that triggers some kind of correction in markets?
Well, I think there are a number of things going on.
So we think the market is very relaxed.
If you look at, you know, people have revised right down any risk of recession.
People, I think, have taken comfort in the limited past three we've seen.
in CPI so far.
But it just seems to me that's all a bit premature.
I mean, you're only now, I think, beginning to know what tariff levels the
US is going to apply.
And it's going to take time for that to fully manifest itself in growth, jobs and
inflation data.
You can see it's beginning to have an impact.
If you look at customs duties raised by the US,
they're picking up pretty quickly so tariffs are happening.
It's just I don't think we've seen them really in the data so far.
So if we do start to see more stagflation, it may shake some of the complacency in
markets.
Markets obviously panicked in April post-liberation day,
and they've actually then reversed all of that and more,
and they're now clearly just focused on things like AI again and so on.
But it just feels as though
Lots of different indicators suggest that the equity market is pretty complacent.
There are some people who've held back on adding exposure, but generally lots of...
indicators on valuation, on things like volatility, on volumes, on breadth,
concentration, all of those kind of things suggest the market is pretty much priced
for perfection.
So if something comes along and jolts that, you could see at some point a
reappraisal.
And so I think that is an increasing vulnerability.
I mean, you could have said it for a while, but given how much or how quickly
the market has reversed.
I think we're sort of, it does look vulnerable again.
On the bond market side, I mean, it's interesting because you can make the case
that the Federal Reserve will worry
more about any signs of a slowdown in jobs than they will about a pickup in
inflation, because to some extent,
the pickup in inflation is a bit like a VAT increase.
It will probably mostly be one off.
You'll see a rise in prices this year to reflect higher tariffs and then the rate
of change next year.
that those numbers will drop out of inflation.
They're obviously concerned about persistence, but if the job market is much
weaker, they'll think, OK, well,
we're unlikely to get persistent inflation.
And so you may end up, ironically,
with a weaker stock market and actually investors happy to own shorter dated bonds
because, you know, the Federal Reserve are switching to rate cutting mode again.
And other central banks as well.
I think it's less of an issue it does seem to be
obviously mostly focused on the US because that's the country raising tariffs.
There'll be a bit of a drag to growth, maybe a mixed inflation probably.
So, you know, their central banks can sort of just respond more to domestic
conditions, I think.
And then you've got the whole question of the longer end, which is really all about
the amount of government borrowing that governments plan
to do over the next few years and how easy that's going to be financed.
So steeper yield curves and lower equities, I think is a definite risk.
if stagflation manifests it, and we think it's too early to conclude that it won't.
But what you're suggesting is if there is stagflation, it's going to be a brief
phenomenon, you know,
as the tariff effect comes into effect, then it'll be a once-off,
and the markets next year, for example, early next year, will start to go back to
normal.
So inflation will start to come down off a higher base rather than the opposite,
which is the case now.
It's going up.
or for low base?
Yes and no.
I mean, I think that's true.
I mean, that's what I'm saying about inflation.
I'm saying that I think the thing that's most significant will be what happens to
the economy, I mean,
to growth and particularly the jobs market.
So if that has weakened, if it weakens much further,
there is a risk that people will begin to revise up again expectations actually that
this isn't just
stagflation, this is...
recess, it's basically a more, it's a more damaging,
more negative backdrop for the global economy.
That is definitely, that's the thing that people have decided isn't going to happen.
So if you look at, you know, the Bank of America fund manager survey, I think
something like 4%
or 5% of people expect a recession now.
And that's down from, you know, high teens, probably post.
liberation day, maybe even higher than that.
So people have basically decided everything's going to be fine.
And that's why the equity market's doing so well.
That's where I think the biggest vulnerability is.
I mean, yes, people worry a bit about inflation and typically higher inflation
is not a good
environment for either bonds or equities and equities probably are worrying about
it less.
But yeah, I mean, I think the thing that's going to scare the market most is if the
US economy
weakens substantially further rather than you know,
just muddling through this year and then actually benefiting maybe from some of
Trump's other policies into
2026.
Given what you've just said over the last few minutes, it's actually quite scary.
And it's scary because of the elevated level of, for example, the United States
stock markets,
the S&P 500, etc.
Because, as you say, they're priced to perfection.
And any little wobble, anything that is not part of that perfection.
can send things tumbling.
I like the way you described the sell-off as a reappraisal.
But if we get a reappraisal like we did in early April, and it's actually based on
something more than just tariffs,
then it could become something more serious.
And on that note, are you and your team mindful of this and positioning yourself
for such an
eventuality?
I mean, yes, to an extent.
I would make two points.
The first is, you know, I mean, the market looks vulnerable.
That doesn't mean it's going to sell off, you know, as we know.
these things can keep going longer than you think makes sense.
And there are also some areas where things look less extreme.
So sort of, you know, so-called real money investors aren't as long as they were
perhaps before, you know,
coming into this year in terms of equity positioning.
But a lot of other things are sort of flashing red.
So there are a few things flashing amber, I think.
The other point I would make is that we've actually lived through over the last
decade or so
an environment where even though the stock market has gone up, every so often you've
had some pretty significant setbacks.
So, you know, 2015, 16, 2018, 2020, 2022, this year, you know,
April, and so on.
So it wouldn't be particularly extraordinary if it happened.
The way that we're taking account of it is we're struggling to some extent to find,
you know,
income generating equities that look particularly attractively valued.
There are some.
We're finding more things that are attractively valued out in the US within
the sort of sovereign bond markets where we think interest
rates are sort of too pessimistically priced in some cases.
But the thing we can do is we can use options to essentially keep a foothold in
the equity
market and benefit if the market continues to go up,
but close our positions without too much of an impact if the market goes down.
So the the nice thing about options they're like insurance and at the moment
because the
market's complacent they're not charging much for that insurance so
you can buy upside participation but not experience the downside or you can buy
downside
protection and continue to own the
long side so either way round you've got a skewed outcome and it's not costing very
much to buy and the analogy I've
used in the past is we're in a sort of tinder dry grassland living in a thatched
house.
There are fires potentially could break out.
The weather's very hot.
But actually, you can insure your house very cheaply.
Why wouldn't you?
And that's where I think we are in the equity market.
John, the final point is that on the day that we record this podcast,
there's been two inflation readings outside of the United States of America.
The first is the UK, where you are, and inflation going up to 3.8% year on year in
July.
up from 3.6% and Rachel Reeves and the Bank of England must be looking at that
with a little bit of concern.
And also going to emerging markets, South Africa's inflation has jumped from 3% to
3.5%.
So it's not just the US, it's also elsewhere and not just developed world
countries.
Well, so I think you've got to look at the trend.
The trend in South Africa actually has been much better than expected inflation.
So if you asked people a year ago, where's inflation going to be, they wouldn't have
said three and a half.
percent yeah um and yet so there are base effects that moves up and down a bit but
ultimately a lot of emerging markets
actually have had a better inflation experience than a lot of developed markets
and yet you can earn pretty high yields in their
bond markets even if you then hedge those the
currency risk back to dollars or sterling you can pick up a decent yield in a market
where actually policy
is pretty conservatively managed inflation actually is better behaved than expected
The UK is a little bit of an outlier.
I mean, I think a lot of the inflation in the UK is essentially because of the
government, because of their policies.
And underneath that, actually, the economy is struggling.
So the labour market's weak, wages are coming down.
The things that have been pushing up inflation are increases in minimum wage,
increases in national insurance contributions.
That's a tax effect.
And then the way that the UK...
prices its electricity is on some, you know, very clunky formula.
And so you end up with actually, I think, inflation being a lagging variable in the
UK.
And unfortunately, we have possibly one of the worst central banks in the world who
spend their life
looking at historic data rather than thinking about where we're going next.
The UK economy, I think, is likely to weaken further.
We're going to get more tax increases.
The job market looks pretty soft.
You know, in a year's time, inflation could be materially lower and the Bank of
England could be well behind the curve.
And actually, they were sort of expecting a slightly worse outcome in inflation into
the latter part of the year.
So it's not a surprise.
John, thanks so much for your time, your analysis.
John Stockford is head of multi-asset income at 91 in London.
The views and opinions expressed in these podcasts are those of Lindsay Williams and
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