As we head into 2023 it is blatantly clear that the world has moved into a stagflationary environment. The theme for investors in 2023 will be centered around the topic of investing during stagflation. In this article we aim to show that 2023 will be characterized by stagflation and we share tips about stagflation investing. Moreover, we make the point that stagflation is not the same thing as a stock market crash.
Note that stagflation characterizes an economy with slow growth, high unemployment, and rising prices. There is inflation in the system but not driven by strong economic growth.
While 2022 and 2023 have a lot of characteristics of stagflation there is one that does not match: unemployment. As 2023 kicks off there is no unemployment challenge.
We can almost conclude that the economy is in a semi-stagflationary environment although readers should not quote us on this. (it’s not an official concept nor term).
We believe that investors need to apply similar principles in the current environment compared to a real stagflationary enviroment.
Stagflation in 2023
This first chart is focused on economic growth. Note that the first two charts are projections made by the IMF.
Countries with high income saw economic growth of 5% in 2021, expected growth of 3.8% in 2022 and projected growth of 2.3%. While there is economic growth, it is at multi-year low levels.
The second chart makes the same point: economic growth is slowing. While the economic growth projections between the two charts are not identical, it is the direction that matters.
Stagflation and markets in 2023
There are quite some data points in markets that confirm the stagflationary trend in 2023.
First, the CPI chart has been on the rise in 2021 and 2022, with a moderating pace around mid-2022.
PPI, the producer price index, is in a similar shape, although it is not moderating (not yet).
Unemployment levels in the U.S. remain very low. There is a small uptick mid-2022 which is one to be monitored closely. It might be that the unemployment level will be rising with restrictive monetary policies, leading the world into a ‘real stagflation.’
Inflation expectations in 2023
Astute readers would argue that inflation expectations have crashed in 2022. So, there is not going to be inflation in 2023, is the thesis.
This is partially correct in our view.
TIP ETF which is a measure for expected inflation came down aggressively in 2022. That’s because of the very aggressive stance of the U.S. Fed as well as other monetary policy makers globally.
However, we believe the decline of TIP ETF has run its course. As seen on the chart, the decline in 2022 touched a rising trendline that is dominant since 18 years.
What this really means is that monetary policies should soften in 2023. Inflation expectations can rise again, presumably moderately (at a more regular pace closer to the 2% desired inflationary rate).
This is an important piece of information because it should be monitored throughout 2023. Stagflation investing can only work if policy makers are not going to over-do it with their restrictive policies. If they go too far and TIP ETF continues to crash in 2023 (below the multi-decade rising trendline) it would result in a market crash.
Stagflation investing in 2023
This one chart should help us understand, directionally, how inflation expectations could correlate with stocks and gold in 2023. This is a key input for stagflation investing in 2023.
Historically, rising TIP (red line) has come with rising stocks and gold prices. Only when TIP declines, like in 2013 / 2015 will it hurt gold. Stocks may not get hit if TIP is consolidating, gold has a hard time with a flat TIP.
We also look at the correlation between yields, stocks and TIP.
Historically, yields tend to move up when inflation expectations decline. So, higher rates on falling inflation expectations. We attribute this to monetary policies: tightening expectations push rates higher because policy makers are not absorbing supply of bonds.
Stagflation investing: a plan for 2023
We come to several conclusions as it relates to asset classes after analyzing the above charts:
- Inflation expectations create a lot of volatility in the bond market. We better be careful with bond investing and only consider investing in bonds when conditions are extreme. In the last quarter of 2022 it looks like bonds have sold off so heavily that they might come with a buy opportunity. However, this likely going to last temporarily. We are ok skipping the opportunity.
- Gold (precious metals) require inflation expectations to rise in order to shine. We believe that gold will rise in 2023 but we must see a confirmation in TIP ETF (rising inflation expectations). The reason why we believe that gold will rise is because of the divergence between the gold price and monetary supply M2. Any divergence, historically, has not lasted for long. Ultimately, if gold will move higher in 2023, we recommend playing silver simply because of its leveraged effect. A pre-requisite for a successful silver setup is a rise in TIP ETF.
- When it comes to stocks, it is a mixed view. Stock indexes may perform well even in a stagflationary environment. That’s because leading indexes are tech heavy: a few heavy weights are able to move indexes higher while there may not be a broad stock market participation.
This last point is key for success. We must be invested in high growth segments and markets. Stagflation investing suggests there is a lot of low growth and exceptionally some high growth markets.
One of the high growth markets we see is in lithium as explained repeatedly:
Australia Looks Good But “Big Lithium” In Australia Looks Astonishing
The Hottest Commodity Of This Decade, The Only One Still Near ATH
Investors should assess other high growth markets. Some of them are niche (think clean energy, they might come with above average risk), others are becoming mainstream (think EVs, they require extensive research for successful stock picking).
The attention point for investors is rates and the expected impact of monetary policies. With rising rates we believe that policy makers will make it tougher to invest in rate sensitive sectors and stocks with high debt levels.
Also, sectors like financials will be volatile in a stagflationary environment. Investors require excellent entry point analysis skills in order to be successful in these sectors.
We expect a lot of volatility and mini-cycles in a stagflationary environment. Investors should buy support levels and exit near resistance or once a breakout has run its course. Taking some profits and not buying close to resistance are tactical tips for investors that want to benefit from stagflation investing in 2023.