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Aug. 30, 2022, 11:53 a.m. EDT

What Is Stagflation & Why Does It Matter For Penny Stocks?

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Aug 30, 2022 (Penny Stocks via COMTEX) -- What Is Stagflation?

Stagflation is an economic term to describe a situation where economic growth is slower, inflation is higher, and unemployment is relatively high. In simpler terms, stagflation is when inflation is high and GDP (gross domestic product) declines.

The latter of the two definitions of stagflation may be more relevant in 2022 and possibly 2023. High prices, lower growth, and a stagnant economy were something experienced decades ago during the 1970s. Companies reduced hiring initiatives as rising energy costs directly impacted operating & production costs.

When unemployment is high, consumers generally have less income and spend less. But during stagflation, unemployment might not be a factor, as in 2022. The July read-out for nonfarm payrolls came in at 528,000, with unemployment dropping to 3.5%, according to the U.S. Bureau of Labor Statistics. Among these figures, the number of long-term unemployed (those jobless for 27+weeks) fell to 1.1 million and accounted for 18.9% of all unemployed people in March 2022. Now we await the next round of jobs data coming up.

What Is Inflation?

You might want to know what inflation is to understand stagflation better. Inflation is a measure of how much more expensive goods and services have become over a period of time. According to the International Monetary Fund, "To measure the average consumer's cost of living, government agencies conduct household surveys to identify a basket of commonly purchased items and track over time the cost of purchasing this basket." These housing expenses also include rent and mortgages.

The cost of this "basket" at any one time relative to a specific base year is the Consumer Price Index or CPI. The percent change in CPI over a period of time is known as Consumer Price Inflation and is the measure that most use to identify actual Inflation. One example that the IMF gives is this:

If Base Year CPI is 100 and the current CPI is 110, inflation is 10% over that period

Is there a difference between consumer price inflation and consumer price inflation? Core focuses on more static trends in inflation. It removes prices set by the government and is watched closely by policymakers.

Why Does Stagflation Matter?

Whether we're talking about penny stocks or stocks over $100, inflation and stagflation matter in the longer term. Sure, you've got individual companies that go against the broader trend. But when there are sweeping economic trends, you'll want to know the factors in play if the trend is your friend. Stagflation can be attributed to several things that result in rising costs and, in turn, lower production rates.

Oil prices are one of the core points of interest when economists view stagflation. As we've seen, due to the Russia-Ukraine conflict, international sanctions on Russian oil have strained the oil market. Looking back at the 70s, OPEC (the Organization of Petroleum Exporting Countries) put embargos on Western countries, causing a rise in global energy prices. This created a snowball effect that hurt transportation thanks to rising fuel costs, which made consumer goods cost more to stock shelves. Ultimately, this led to layoffs, further contributing to the economic theory.

In the 1970s, factors related to monetary and fiscal policies added to the situation. The Fed Chairman at the time, Arthur Burns, eased monetary policy in response to higher commodity prices. This allowed inflation to continue.

Stagflation can also put pressure on bond prices while also muting valuations. Households earn less money. Yet another snowball effect comes to light as slower spending can impact corporate revenue and expand the overall impact across global economies.

The best example of stagflation came during the Nixon era, which saw the U.S. remove itself from the gold standard. It also saw a 90-day freeze on waves and prices and a 10% tariff on imports. Attempting to combat stagflation, the Federal Reserve raised the Fed Funds Rate to fight inflation but lowered it to combat a recession. This start-stop policy strategy didn't help the overall economy and ultimately increased inflation altogether. In addition, OPEC's oil embargo on the US triggered price spikes in energy. Businesses passed this cost along to consumers while also curbing production. A recession ensued in the early 1980s to reduce the spiraling inflation.

As you'll see on the S&P Index chart below, the period between the end of 1971 through 1982 saw declining market prices. Since the S&P 500 ETF ( NYSE: SPY ), Nasdaq ETF ( NASDAQ: QQQ ), and Dow ETF ( NYSE: DIA ) weren't "born" yet, we'll go directly off of the SPX:

The hope right now is that those in charge of economic policy have a better handle on current conditions than the case 4 decades ago.

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