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- Today's inflation concerns mirror those seen after the 1980 economic slump. And James Paulsen, chief strategist at The Leuthold Group, sees the trend as a boon for markets.
- The inflation surge seen four decades ago kicked off "a fabulous 'disinflationary,' two-decade performance in both the economy and the stock market," he wrote in a recent note.
- With policymakers setting the stage for a rise in inflation, the US is on track to usher in a similarly fruitful expansion, the strategist added.
- Detailed below are the eight reasons Paulsen sees the current inflation scare leading to a thriving economy and strengthened bull market.
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Inflation fears today mirror those seen during the 1980 recession. That similarity may be what saves markets from their own lofty valuations, according to James Paulsen, chief strategist at The Leuthold Group.
Stagnant price growth has plagued the US economy for years, and the coronavirus pandemic only worsened the problem. The Federal Reserve cut rates to zero, kicked off an unprecedented asset purchase program, and boosted the nation's money supply in an effort to keep inflation stable through the downturn.
Investors now fear such conditions will stifle a recovery from the current recession, but history suggests the opposite, according to the strategist.
The 1980s inflation fear spike sparked "the beginning of a fabulous 'disinflationary,' two-decade performance in both the economy and the stock market," Paulsen said. The initial scare motivated a coordinated effort to right the economy. Such a solution will likely emerge once the coronavirus is contained and policymakers focus on stabilizing inflation.
Detailed below are the eight reasons Paulsen sees today's inflation scare giving way to a thriving economy and surging stock market.
Demographic shift
The US working-age population's decade-long annualized growth reached a record-low 0.3% this year, slumping in a downtrend similar to that seen starting in 1980. The past drop eventually reversed and led to a growth in the working-age population, a shift likely to repeat itself in the coming years, Paulsen said.
"The size of the Gen-X age group is set to exceed the Baby Boomers in a few years," he wrote in a note.
That shift is partially behind the housing market's strength through the pandemic, as Gen-X Americans reach "prime household-formation years." As the group ages further, they'll reach "peak spending years" and accelerate the nation's economic bounce-back, Paulsen added.
Immigration vs inflation
The country is also likely to pad its demographic trends by allowing for greater immigration over the next few years, the strategist said. Doing so "could make underlying economic-resource growth far stronger than currently anticipated."
Turning the trade tide
The economic rebound could be accelerated further should the US aspire to finally reach a trade surplus, Paulsen said. Trade balance data released Thursday showed the country running a deficit of $63.6 billion, its widest since 2008. A policy of enforcing fair-play trade among economic superpowers could improve the US's trade competitiveness and lift the economy, according to the strategist.
Boosting export activity would have a direct and powerful effect on national gross domestic product. Paulsen noted that, in a hypothetical scenario where the balance shifts from a 1% deficit to a 1% surplus, US GDP would improve an entire 2%.
Closing the output gap
The nation's output gap — a measure of the under-utilization of economic resources — sits at a post-war low. Such a disparity leaves "considerable room for improvement" when the pandemic ends and the US puts its resources back to work, Paulsen said.
Permanently low-cost
Companies battened down the hatches to ride out the pandemic, and that cost-cutting could end up speeding up the nation's rebound. Lowered breakeven points will yield greater profits when activity picks up, Paulsen said. The trend will also justify stocks' historically high prices as investors pay up for "uncommon earnings leverage," he added.
Recipe for productivity
The latter two predictions come together in Paulsen's forecast for a surge in productivity. "Hyper-efficient companies" and the strong potential output-gap improvement suggests economic productivity "could surprise to the upside" throughout the recovery, he wrote.
Poised to spend
Households are unusually prepared to drive the economy out of its slump compared to past downturns, according to Paulsen. Americans spent more than a decade paying off debts, refinancing, raising their net worths, and growing more cost-efficient. Homes now tout a savings rate close to 20%, "an uncommonly liquid status quo" that stands to ignite a strong new expansion, the strategist wrote.
"How much could economic growth be bolstered should household-sector attitudes turn optimistic about the future?" he added.
Government backing
Lastly, Paulsen sees the government's "amazingly aggressive" monetary and fiscal policies buttressing the nation's economic rebound. The Federal Reserve recently overhauled its policy framework to better control inflation as it expects to hold interest rates close to zero through 2022. Congress remains in a deadlock over new stimulus, but economists still expect a package to arrive before the November election.
So long as the government and the Fed keep their relief efforts intact, Paulsen expects the backdrop to usher in an expansion to rival even the most bullish outlooks.
"Just as the restrictive policies employed in 1980 helped to break the inflation surge, it seems probable today's unique and massively accommodative economic policies will quicken future economic growth more than thought," the strategist wrote.
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