Don’t Let Stagflation Get You Down

Rising Inflation and Slow Growth Take Shape

Reviewing Our Portfolio Before the Economy Declines

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Times were tough, and steak was even tougher.

It was New Jersey in April 1973, and James Leone had just opened his new butcher shop, Leone’s Meat Market, in the front room of a former pizza parlor.

The cuts on sale? Filets, rib roasts, and sirloin tips – all carved out of prime meat… prime horse meat, that is.

And sold to hungry humans, who were fed up with soaring nationwide beef prices that had doubled during the past year.

Protesters lined the sidewalk in front of Leone’s shop, waving signs like “Stop Eating Horses” and “Would Roy Rogers Eat Trigger?” But the reality was, in the depths of 1970s stagflation, the famous movie cowboy might have fricasseed his trusty steed, too. 

The picket lines were long, but the line of customers was longer. An hour after the grand opening, Leone had sold out of horse filets and made a sizable dent in the rest of his 10,000-pound inventory.

“I love horses,” he told the New York Times, “but the economic situation has placed normal table meat beyond the reach of most people. We're here to provide the public with quality meat it can afford.”

It was the nadir of the 1970s economic slump – a time of stagflation and stallion filet. Runaway government spending on the Vietnam War, amplified by the massive expansion of social welfare programs, pushed the U.S. government budget deficit to the highest levels since the Great Depression. Predictably, the government printed more paper to finance the borrowing – so inflation surged. Yet growth remained weak, as much of the government spending went to nonproductive areas of the economy. 

Finally, Fed Chair Arthur Burns had bowed to intense pressure from President Richard Nixon to keep monetary policy easy ahead of the 1972 presidential election – which allowed  inflation to become entrenched in the following years. 

This lethal (and unusual) combination of high inflation and weak economic growth crushed the economy. Between 1971 and ‘79, prices in the U.S. rose 92% – meaning American purchasing power was nearly cut in half. Wages stagnated, while both stocks and bonds suffered a decade of negative real returns (i.e., returns after adjusting for inflation). All this, while Americans waited in mile-long lines at the gas station during an Arab oil embargo that caused fuel shortages.

Faced with prohibitive beef prices in the early 1970s (along with rising prices on countless other consumer goods), many hungry U.S. citizens turned to alternative sources of meat. And it wasn’t the first time: Historically, horse meat has been an entrée of last resort. World War II food shortages put ponies in the pâté, and besieged Parisians consumed all 70,000 steeds in the city during the 1870 Franco-Prussian war.

Fast forward to 2024… and we may end up pulling the trigger on Trigger yet again… 

Though we’re not there yet, those who remember the turbulent 1970s will see eerie echoes of that era today. As we’ve written before, runaway government deficits means high inflation and high interest rates are here to stay. That means consumers will continue feeling the pinch from sluggish income growth and higher costs. As they pull back on spending, growth will slow further. But unlike a typical recession, sticky inflation means the Fed can’t come to the economy’s rescue. 

It’s stagflation all over again. (We’re even currently experiencing the worst beef shortage since the 1970s... you can draw your own conclusions from that.)

In February, we warned that a slowdown was coming, even among resilient consumer staple companies like spice-maker McCormick (MKC), fast-food giant McDonald’s (MCD), and coffee retailer Starbucks (SBUX). The most recent Q1 earnings reports make clear that this consumer pullback has turned into outright retreat.

The SBUX Stops Here

The biggest surprise came from Starbucks, which just reported dismal Q1 results. The company experienced a 4% decline in same store sales (“SSS”) – sales from existing stores, excluding the impact of new store openings – the biggest drop since many of its locations were still closed during the pandemic. This marked a sharp reversal from just two quarters ago, when the company reported 10% SSS growth in Q3 2023. Management cited “a deteriorating economic outlook has weighed on customer traffic, an impact felt broadly across the industry.” 

Starbucks is just one example of many. For now, the bottom line is clear: the recent string of data indicates the long-awaited recession may be rapidly approaching. We believe investors should brace for more weakness in the economy and in financial markets. 

That means maintaining a defensive stance across your portfolio. Hold fewer high-risk, cyclical stocks with exposure to consumer spending and overall economic activity. And maintain a strong cash position. We expect attractive bargains to emerge when the economy regains strength after the coming downturn.

And for the capital you choose to keep invested in the market, focus mostly on the highest quality companies. The kinds of world-class, capital efficient businesses we regularly recommend in The Big Secret on Wall Street portfolio. 

With deteriorating economic conditions in mind, we are devoting this issue to an expanded portfolio review – looking at five of our holdings that are finding ways to win in this new stagflationary-looking environment. Companies like the world’s leading pizza maker, Domino’s…