Australia | Jun 08 2006
By Greg Peel
Stagflation is a word that hasn’t been dragged out much since its popularity in the seventies. Loosely, it means slow economic growth coupled with high inflation. (It should mean high unemployment too, but we won’t worry about that for the moment).
We are currently undergoing a stagflation scare, with the US leading the charge and the markets crumbling on the back of sermons from the pulpit of the Fed, and economists concerned that the Fed is going to stuff it all up yet again. Economic growth indicators in the US show slowing, inflation indicators show a rise. SB Citigroup suggests the stagflation scare is the "first serious test of the robustness of the super cycle during the 2000s".
Try as you might, it’s hard to find an economist who is really concerned about inflation. Oh they do exist, but the bulk of research that comes across the FN Arena global economics desk is very much skewed towards a belief in a jump in headline inflation (largely driven by the oil price) but little expected jump in core inflation. What we are currently experiencing (in Australia too) is cyclical, not structural inflation, they decree.
Citigroup notes US productivity remains around 2.5%, and the industrialisation of China will definitely continue, albeit at a deliberately slower rate. There are distortions, however, with China’s oil price subsidies forcing higher petrol prices on the rest of us, as well as a global shift towards monetary easing (particularly in previously stagnant Japan and Europe) which will only serve to lift inflation in the short term.
The lift will not be structural, says Citi, because there is still excess supply coming out of Asia, and the US and Chinese economies will slow as the US housing sector slows, and as the US consumer starts giving it a rest, and as Chinese policy focuses on slowing construction and addressing energy subsidies. There will be a cyclical rise in inflation however, and this will yet assure a "bumpy ride".
Having said that, Citi’s strategists are heartened by the fact that they declared we had to have a correction, back in the first quarter, and now we’re having it. In Australian terms the market is heading back to what Citi deems to be fair value. Have a seat – Citi’s central point of fair value is 4643 in the ASX200. As I write, we just sailed through 4950.
Citi advises caution at least until the market breaks 4900, which at this rate might be next week. "Capital preservation and discipline are necessary" says Citi, until the big, bad bear of stagflation runs back into the woods and Goldilocks can tuck into the porridge once more. (Many economists like to use the "Goldilocks" parallel to describe the current global economic situation – just right).
It may yet take time for this to occur, warns Citi, until the market gets over its panic phase and wakes up to the current cyclical nature of inflation rises. In the meantime, the super cycle is intact.
Repeat after me: the super cycle is intact.
In bond markets, Citi sees fair value in Australia at 5.3%, so a rally can be expected once the inflation dust settles (bond rally means yields fall). This has implications for how one should set one’s portfolio as the market falls.
Citi advises hang on to resources. You can’t get out now unless you foolishly don’t have super cycle faith. Gold is good to have in times of inflation worries. Banks perform better in a lower yield environment, and they’ve been trashed as well so they make good buying. Infrastructure has been a dirty word since late last year, so those stocks represent value now. Property Trusts are still, unfortunately, an Underperform.
UBS strategists support Citi’s inflation view. Their expectation is for a "minimal" pick-up in core inflation and a slowing of economic growth. One more rate hike from the Fed, says UBS, and that’s it. As this is already priced in, UBS sees bond markets from here being "relatively benign".
Infrastructure is UBS’ preferred sector pick, with Banks and Property trusts not providing as much valuation potential in the analysts’ view. Telcos should be something to look at, but don’t.