Here's How Wall Street Defines "Stagflation" And Why "Markets Could Be Massively Mispriced"

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by Tyler Durden
Sunday, Oct 10, 2021 - 11:00 PM

It is easy to understand why Wall Street is increasingly worried about Stagflation: with the Citi global inflation surprise index surging to the highest level ever (granted, it only captures the period since 1999 so it's unclear how it compares to the 1970s or early 1980s inflation shock periods)...

... Citi's economic surprise index has turned negative and slumped to levels which historically have indicated an economic slowdown if not outright recession.

As a result, it's also easy to understand why some of Wall Street's strategists have taken it upon themselves to ease investor concerns that another 1970s stagflationary shock may be coming, most notably Morgan Stanley earlier today, which admits that "it’s not hard to see why one term seems to come up again and again in conversations with investors: stagflation" but counters that in its view the surge in energy prices is temporary, and that the most comparable period to the current stagflationary scare is more comparable to 2005 when "CPI hit 3.5%Y while the US manufacturing PMI had fallen to 52. 'Stagflation' graced the cover of The Economist. These fears eventually passed as growth rebounded and inflation moderated, but we think that 2005 may provide a useful reference point for a scare that comes far short of the 1970s. Equity multiples de-rated throughout 2004-05, consistent with the current forecasts for my colleague Mike Wilson and our US equity strategy team." (more in the full note here).

Yet as Morgan Stanley also admits, while the "market is focused on stagflation, it just hasn’t quite decided what that term really means."

So to help shed some light on what most Wall Street professionals think when they hear the term "Stagflation", today we publish a second post on the topic of stagflation, in which we point readers to the latest monthly survey conducted by Deutsche Bank's Jim Reid who asked just this question and agrees with Morgan Stanley that "one of the problems that the survey throws up is how we define “Stagflation”. It also shows the perceived elevated risks of it."

Here's what the survey found:

  • 43% define Stagflation as “growth around zero or negative and inflation well above target”
  • 30% define Stagflation as “growth below trend and inflation comfortably above target”
  • 25% define Stagflation as “a strong slowdown in growth and strong pickup in inflation”

As Reid notes, although the top most negative definition is the most popular, there is a relatively even split of definitions out there. "This is important because there’s a huge potential difference in the impact of these scenarios on global markets over the next 12-18 months. So when the term is used we have to be careful to understand the definition behind it."

Reid also admits that he was very surprised how strong the consensus is now that stagflation of some kind is more likely than not over the next 12 months: for the most aggressively negative definition, the very high or high risk is still “only” 22% and 33% for the US and Europe. It is a stunningly high 54% in the UK though.

Surprisingly around 40% think the US is at risk of growth being below trend over the next year which given that consensus forecasts for GDP growth in 2022 is c.4%, feels quite aggressive.

What this means in practical terms, is that if these numbers are proved correct, "markets could be massively mis-priced", according to the DB strategist. The silver lining to Reid, and here he is somewhat in agreement with Morgan Stanley, is that his "gut feel" is that while the risks are elevated, especially on the inflation side, "the phrase “stagflation” is being used too aggressively at the moment."

The next few months will prove if he is right.