Previously, I talked about the last popular Bridgewater item that made the rounds. They are out with another similar note today on their prediction that we are headed for stagflation.
The note generally updates their prior call for current implied financial conditions, namely how markets are predicting that the Fed Funds rate will go up to somewhere in the mid-high 3s by next year and then cuts will start. Bridgewater thinks that this will not be enough and political forces may keep the Fed from breaking the back of the economy to truly tame inflation, potentially causing a second tightening cycle. They note:
Thus, the degree and duration of the tightening must be strong enough and long-lasting enough to bring credit growth down by enough (roughly by half ) for long enough—to bring spending down by enough for long enough—to weaken labor markets by enough—to bring wages down by enough—that NGDP growth falls by enough and stays there—to bring inflation down to 2.5%. Historically, the average lead time of a decline in labor markets to a decline in wages is about two years, with a wide range around that average.
As mentioned, we doubt the scenario that is now discounted in the markets and think that the odds of a protracted stagflation are much higher. Our systems suggest the same for the near term which now doubt the degree of near-term tightening that is discounted, the 2.5% terminal inflation rate that is now priced in, and the future level of earnings that is now priced in, reflecting instead the growing vulnerability of the dollar should those doubts prove true.
Basically Bridgewater says that the Fed needs to do major damage to credit, to do major damage to spending, to damage wages, to blunt overall growth and thus inflation. I do feel like we may be at some sort of crossroads, with one direction supported by fear mongers like Bridgewater and the other being that the market is right. But “feeling” something isn’t actionable.
As an investor just focused on staying in the game, none of this really matters as an input. Sticking with a process that is conservative and just keeps one in the game, is indeed what matters.