While employment remains relatively robust, there are growing concerns about the potential risk of stagflation. Greg Bonnell speaks with Alexandra Gorewicz, Portfolio Manager, Active Fixed Income, TD Asset Management, about the implications for markets.
- Well, you may be seeing the term "stagflation" thrown around out there as investors try to figure out where we are headed next. What does that actually mean for the economy and for your portfolio? Here to discuss, our guest of the day, Alex Gorewicz, Portfolio Manager for Active Fixed Income at TD Asset Management. Alex, great to have you on the program.
- Thanks, Greg. Great to be here.
- Let's talk about the stagflation talk. Obviously, nobody knows exactly where we're headed, but the term keeps cropping up every once in a while. What would that actually mean-- a period of low growth and high prices? What do we need to think about as investors?
- So I think stagflation gets thrown around a lot without people actually thinking of the real definition, which would be, let's say, no growth or potentially even recession, but inflation being high or prices continuing to rise, in fact. And then there's the third component, which is unemployment.
And unemployment in stagflation tends to increase, despite inflation being high, because of the growth aspect. Now, we've been hearing this word thrown around over the past year or so, despite labor markets being very strong and unemployment continuing to fall. And in part, it's been not because of growth being negative or necessarily falling, but because expectations about growth have been revised lower, and expectations around inflation, and then, obviously, realized inflation moving higher. So the trend on all these three different metrics have been towards stagflation without actually necessitating that term in a sort of definitional sense.
- It's the kind of scary scenario that people do not want to find themselves in. What does an investor do if you end up in an environment like that? What are we talking-- it's been 40 years since people have had to worry about this?
- That's right. So when you say 40 years, the last known stagflation period in the modern era was in the 1970s. And it's very easy to draw comparisons to that point in time from an investing perspective, because both stocks and bonds have generated very negative returns this year. But we also have to appreciate the differences, both economically as well as financially, from today compared to the 1970s.
So in the 1970s, our economy was geared a lot more towards manufacturing. So when we had the oil shocks and when we had a series of price pressures building during that time, the impact to the real economy was significantly greater than it could be today from, again, an output perspective. From the financial sense, we also had a market that was less, I guess, developed, in some sense, than we see it today.
So for example, high yield bonds didn't really exist-- or if they did, they were a much niche-ier segment of the market. Derivatives, hedging instruments-- all kinds of financial assets that we use today to express our views didn't exist at that time. And one other thing, and, actually, this is a big one too if you look purely at stocks-- compositional differences.
At the time in the 1970s, you would have had a lot more stocks that represented, again, the real economy, very manufacturing based. Whereas today, even a broad-based index like the S&P is more geared towards growth stocks. And so when we think about all the different elements that make up our economy today and make up our financial markets today, we can't just draw some conclusions that, oh, if this happened in the 1970s, then it must happen again today. And so it just necessitates being a little bit more nimble and a little bit more like thoughtful about how you invest portfolios.
- That's good perspective to know that just because it happened once doesn't mean it's going to happen exactly the same way again, or at all. Let's talk a little bit more about the job market, because I guess the headlines have all been recently, if there's an advantage, it's an advantage to the worker. The labor market is tight. Workers can call the shots.
But now you're getting corporations saying, well, we fear a recession. And we fear that, perhaps, that will mean trimming back on our workforce. Where is the truth lying here?
- Yeah, so there's no doubt about the fact that labor market's very strong. We've seen across multiple sectors high turnover, right? People changing jobs, they find other opportunities, higher pay, perhaps-- and they're taking advantage of those. When we look as well as job vacancies, we see that they're at record high. And so, again, this creates this notion that employees have a lot of power here-- that labor has a lot of power in the market.
So all of this feeds this perception that job market is very, very strong and that it could persist. But it's important to note that, even before the pandemic, there were record job openings. And when you take that into perspective, this idea that, OK, we're headed towards very fast tightening in monetary policy and that should have only a marginal impact on the labor market-- it's not necessarily the case, because this notion of high job vacancies existed largely because of a skills mismatch between what corporations were looking for or what employers were looking for versus the skill set that existed.
And how much of that goes away as sort of the spare capacity in the labor market today versus existing employees being laid off is a big question mark. And I think from our perspective, at the active fixed income team, if we look at the job market today, we're actually worried that more companies are feeling the price pressures and that it doesn't take very much for unemployment to start ticking higher across multiple sectors, not just the ones where we know the price pressures have been most acute.
- So many big questions out there right now. What about the growth versus inflation story? How is that playing out in the markets?
- So that seesaws almost from day to day, but certainly from week to week. So after the CPI print in the US, we had the fear that, OK, inflation is not rolling over. The peak is not behind us. And so markets went ahead and started pricing a lot more interest rate hikes.
Interest rates rose, stocks rolled over, and then the Fed delivered 75 basis points rate hike. Then we had a reminder from here at home, with yesterday's CPI print in Canada, that inflation is making new highs-- which, by the way, the Bank of Canada had warned us about and it's actually happening. And so when we look at the-- call it the inflation side-- there are real concerns for the market.
We can't put it behind us. But then there's the growth element. So we start looking at PMIs now, leading indicators. These are aspects that tend to lead recessions or at least a significant growth slowdown. Well, we had some pretty big misses on PMIs today out of Europe and out of the US.
What does that mean for growth? And that's generating a bit of a risk-off tone today-- well, not so much risk-off. You showed at the start of the show how stocks are doing, and they're not doing too poorly. NASDAQ, in particular, is up today because real rates are falling.
And why are real rates falling? Because the market's saying today, well, OK, inflation is still a problem, but growth might become a bigger problem much faster than we were expecting. So it really depends. From one day to the next, you could have the narrative change very quickly, and then the market would whip around on you.