Is Stagflation the New Sharknado?

You know what’s a really scary combination? Sharks in a tornado? Nope. Snakes on a plan? Nope. What should really chill your blood is stagflation. This is the ugly stepson of growth stagnation and high inflation.

Stagflation – uh what?

Stagflation is the combination of poor economic growth, usually combined with recession features, such as high unemployment along with a rapid increase in prices. Poor growth or a recession on its own is pretty ugly, but when you mix in significant increases in the cost of living you have a whole boatload of sharknados.

It’s also the nightmare scenario for those seeking, and living early retirement. Not only are your living expenses increasing in real terms, but the investment returns can’t even keep pace with the cost of living. A safe withdrawal rate is predicated on earning an investment return on your savings that is growing in real terms. In other words your asset are growing faster than the cost of living and that’s what allows you to cream off some investment earning to live on. In a stagflationary environment, your savings are shrinking in real terms.

Is this fiendish scenario on the horizon?

It popped into the news recently when Alan Greenspan the former Federal Reserve Chair suggested that the US might be heading for stagflation. Luckily for us he was rounded upon by knowledgeable commentators and discredited for this view. It seems unlikely that we are heading for stagflation, but never say never.

It’s useful to look at the causes and what we can learn. In classical economics it was thought that stagflation was impossible, since inflationary forces usually counteract recessionary forces. However in the 1970’s there was “cost-push” inflation from oil coupled with the US moving away from the gold standard. The Fed were now faced with a conundrum – lower interest rates to promote growth, and raise interest rates to curb inflation.

So you can see you need some crazy stars to come into alignment to get this kind of economic sharknado. But let’s play with some crazy scenarios for a minute. Maybe geopolitical tensions results in the detonation of a thermonuclear device that sends global growth plummeting and investor confidence down the toilet; but in response the President and Congress (in an unprecedented show of unity) pass a massive economic stimulus package with record levels of infrastructure and defense spending (sound familiar?).  The danger is high inflation without concurrent growth resulting in – you guessed it – stagflation.

What does it mean for me?

Let’s look at some past real equity returns and how that could impact on your future ability to meet your FI commitments. I’ve taken my figures from the mind blowingly comprehensive Siegel’s Stocks For the Long Run. It’s a great read!

Real Return (CAGR)
US Average 1926-1997 7.0%
Germany 1926-1997 6.6%
UK 1926-1997 6.2%
4% Rule 4.0%
Japan 1926-1997 3.4%
US Stagflation 1966-1981 -0.4%

What you notice is the robustness of the equity returns over the long term, and even in countries whose stock markets suffered in the Second World War. There is one significant period of stagflation for the US and it is shown above with a compound real growth rate of -0.4%. The 70’s really were the lost decade for the stock market.

Let’s look at how much money you would need today to fund $40,000 a year for the next 50 years based on each of those real return assumptions.

Real Return Sum Required $’000
US Average 1926-1997 7.0%                   552
Germany 1926-1997 6.6%                   581
UK 1926-1997 6.2%                   613
4% Rule 4.0%                   859
Japan 1926-1997 3.4%                   955
US Stagflation 1966-1981 -0.4%                1,099
Nifty chart!

If stocks return 7% net of inflation then you only need $552,000 to cover $40,000 per year for 50 years. If stocks return 4% real return then the sum required is $859,000. You might have been expecting a sum of $1,000,000 for 4% return, however $1m would be required to fund $40,000 in perpetuity, not just 50 years.

Now look at the stagflation. Here I have taken -0.4% for 15 years followed by a +4% return for 35 years. This dramatically increases the amount to $1,099,000, and you need 28% more money than implied by the 4% rule. It’s ugly but probably not a disaster, since there are many strategies you can employ to mitigate this downturn in fortune.

There is plenty of information in the FI community about building a flexible withdrawal strategy, side hustles, and geo-arbitrage. These are all tools to help you survive this disaster – but they might be useless in the event of a sharknado (just warning ok?).

What are you going to do?

What are going to be your tactics to survive a stagflation environment? Does it keep you up at night? Or are you more worried about sharks dropping from the sky? Either way, let me know!

 

 

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