The Coming Price and Wealth Squeeze?

There are many things to be worried about in the world today.

One item on that list is the possibility that we could be heading into a period of stagflation.

Inflation usually presents itself in a prosperous period. Demand outstrips supply which results in inflationary pressures on a broad range of the prices of goods and services. The good news is that most people have jobs and money in their pockets despite the rising prices.

Stagflation also involves inflation but occurs at the same time that there is slow or declining economic growth and the unemployment rate is increasing.

Stagflation is the worst of all worlds. Rising prices at the same time that people have less to spend.

It is no fun. I was around in the 1970's when we last experienced it.

Where I sit today I foresee there could be an even worse world than stagflation.

Combined with stagflation, my fear is that we could see an even worse situation with a price squeeze in which prices on things that people need to live (food, gasoline for transportation, energy to heat and cool their homes) are rising at the same time that we see the asset price of stocks, bonds and homes declining. 

Stagflation combined with that type of price and wealth squeeze would be an economic calamity of gigantic proportions. 

We already know about the damage that inflation is having on the American people.

Consider these price increases over the last 12 months in selected commodities that directly affect the lives of Americans each day.

Source: https://twitter.com/charliebilello/status/1505139838705713159

Then consider how much the asset prices of stocks and houses have increased over the last two years propelled by the easy money policies of the Federal Reserve.

The total monetary base has increased 78% in the last two years which has fueled increases in asset prices for stocks and housing.

Increases in the stock market and housing prices have a positive wealth effect. Increases in these asset prices make people feel richer and history has shown that this wealth effect makes people more willing to engage in consumer spending which is a real driver of the economy.

The S&P 500 is up 94% over the last two years. Coincidentally, the market bottom over the last five years was reached on March 20, 2020, exactly two years ago just as the Covid lockdowns were in their initial stages.

S&P 500 Index

The NASDAQ composite is up 102%.

NASDAQ Composite

The NASDAQ 100, which includes many of the companies in the tech area that have benefited the most from the dislocations of the pandemic (Amazon, Google, Apple, Microsoft, Apple, etc), is up 106%. This index is up 169% in the last five years.

NASDAQ 100

Yes, these stock index increases are all being compared to market lows two years ago when there was a lot of fear and uncertainty about the future.

A lot of those tech names developed broader and more entrenched market positions in the last two years.

However, are those asset prices sustainable in an environment with higher interest rates that gives investors more attractive options to invest their money than we have had the last several years?

What about housing prices?

This chart shows increase in housing prices nationally on an annual basis calculated each quarter since 2019.

Prior to 2020 we were generally seeing increases averaging 5%-6%.

In the last two years this increased from the 10% range in 2020 to 16%-18% in recent quarters.

Source: https://www.ceicdata.com/en/indicator/united-states/house-prices-growth

In many areas of the country, price increases have been much higher.

Increases in housing prices have made many people feel wealthier just as the stock market has.

However, let's put that in context by comparing it to incomes.

The median full-time worker in the United States earns $50,000 per year.

The price of the median-priced home increased by $53,000 last year.

Those increased home values has made every homeowner feeling a little wealthier.

However, the Federal Reserve now actually owns $2.8 trillion of mortgage debt on its balance sheet through mortgage-backed securities. Before 2009, it did not hold any mortgage debt.

The Federal Reserve actually holds almost 25% of the mortgage debt in the country.

Is this sustainable in any way?

The wealth effect makes everyone feel good except those who want to buy a home and can't afford it.

Someone on Twitter put it this way. 

If have been in the market to buy a home, you have not been competing with other homebuyers. You are competing with a printing machine.

It is all great until it isn't there any more.

A large reason for this has been the very low interest rates which the Fed made sure were kept low.

House prices are very sensitive to interest rate hikes.

Each increase in mortgage rates prices more buyers out of the market and reduces demand. This inevitably puts pressure on house prices.

The value in people's houses or the balance in their 401(k) account does little to pay the bills right now.

What happens if those things that people need everyday to live continue to increase at the same time that the assets they own are declining?

This would put many in a price and wealth squeeze that might come on top of stagflation.

Inflation in those things people need everyday. 

Deflation in the values that make up most people's wealth (stocks and houses).

That would be an ugly combination.

Let's hope that this is not the next worry that becomes a reality.