Beware the Coming 'Stagflation'

Omicron is getting started in China... Flashbacks to January 2020... More supply-chain issues and inflation... Beware the coming 'stagflation'... 'What stuff is going to be available and when'... What has bullish tailwinds now...

Omicron is just getting started in China...

Its capital city, Beijing, "officially" reported its first case on Saturday night.

It's not an entirely surprising development given that the COVID-19 variant has been reported in other cities in China during the past week... and that it seems to spread as easily as dust in the wind.

But things are about to get more complicated...

In just three weeks, this metropolis of 21 million people is scheduled to host the Winter Olympics and the entire country is going to celebrate Chinese New Year... which means a lot of visitors, gatherings, and travel.

Olympic athletes have already started to arrive in China from around the world... and the annual New Year's celebration typically sees millions of its citizens travel to see family and friends, like the holiday season in the United States.

The Chinese government and health officials are predictably on edge...

The Communist government wants to stomp out an Omicron spread ahead of these celebrations and is enforcing what it calls its "dynamic zero COVID" strategy, which includes constant testing, nationwide monitoring of people's movements, and phone apps.

They've ramped up COVID-19 testing in Beijing and other Chinese cities, strengthened travel restrictions, isolated workplaces, and even seem to be starting a propaganda narrative about the virus' spread, pointing the finger at Omicron arriving in the mail from North America...

According to the French international news service Agence France-Presse...

Health official Pang Xinghuo told reporters Monday the virus had been found on the surface of a letter the infected person had received from Canada, as well as inside the unopened letter.

Before going further, we'll just say bluntly that we believe the likelihood of that single paper letter being the single source of Omicron's spread to China's capital city is unlikely.

The point is, the second-largest economy in the world has a renewed COVID problem...

If we've learned anything from this pandemic, it's that the virus is likely to spread around China, like it has seemingly everywhere else.

Whether all the cases and positive tests get accurately reported or not, we don't know, and what the Winter Olympics and the Chinese New Year will look like in a few weeks, we're not sure...

But I (Corey McLaughlin) start with this report today not to raise concern that we won't get to watch cross-country skiing or speedskating in a few weeks on television...

I bring this up to consider what COVID-19 in China (again) means for the rest of the world... That includes stocks and other assets, the global economy, and how this may play a role in the way the world's central banks handle policy in the months and year ahead.

We're starting to see some of this scenario play out already.

Directly or indirectly, it contributed to stocks and most other assets – except oil and shares of video-game company Activision Blizzard (ATVI) – sliding across the board today...

The benchmark S&P 500 Index and tech-heavy Nasdaq Composite Index were down roughly 2% today.

I'm having slight flashbacks to January 2020...

That's when we first wrote about a little-known coronavirus in China, at the time being called the "Wuhan virus."

We noted in the January 22, 2020 Digest that it was a particularly bad time for a potentially deadly, contagious new virus to appear... considering the massive travel period for the Chinese New Year that was about to happen in the country...

Few people, including us, understood the extent of what was about to hit the world with the COVID-19 pandemic.

Almost two years ago today, I referenced a statement from the U.S. Centers for Disease Control and Prevention ("CDC") that the risk of the virus spreading to the American public was "low"... Boy, were they wrong.

Since then, we've learned a lot about life in a pandemic...

And we're not going to ignore the signs of history repeating itself again...

When it comes to the economy and markets, aside from again seeing how massive stimulus can distort the value of money... probably the biggest lesson that might be taught about all this is how supply chains were disrupted.

Different countries, cities, and parts of the world have dealt with COVID-19 peaks and valleys, and supply and labor problems, at different times.

For most of the pandemic, COVID-19 waves have originated in Asia, Europe, or Africa before hitting the U.S.

The "original" COVID-19 came from China (yes, I'll say it)... The Delta variant took hold in India... And the Omicron strain evidently sprouted from South Africa...

The mismatched timing had altered global supply-chain efficiency...

Over the last two years, what was happening in New York or ports in Los Angeles was not necessarily happening in Beijing or London... at least not in identical fashion at the same time. If one economy or labor market was "strong," another could be "weak."

One example... Producers of things like semiconductors in Taiwan weren't able to keep up with the demand for their products from tech buyers and car companies in the U.S. So we've seen shortages in the supply of new cars that depend on these chips to work...

Today, in the U.S., tens of thousands of workers are calling out sick, there are still backups at ports, and airlines have been canceling thousands of flights. We can only hope that Omicron peaks in the U.S. soon, but now things are ramping up in China...

This means supplies coming out of China (again, the world's second-largest economy) – like electronics or everything you see that says "Made in China" – could slow down or be stuck longer on ships.

Already, there are reports out of Chinese port cities experiencing congestion and weeklong delays... In Tianjin, a city of 14 million, people, carmaker Toyota suspended operations at its plant.

This is all happening while, relatively quietly, China's economic growth has slowed down, to the point that the Chinese central bank lowered a key lending rate recently, as our Stansberry NewsWire editor C. Scott Garliss wrote today... just the opposite of what is happening here.

At the same time, demand for Chinese products in the U.S. and other nations will remain at least steady for the most part.

In short, this means you're going to hear about more supply-chain problems... and that means more fuel for the inflation we have seen, as demand continues to outstrip supply...

And it could also mean an economic slowdown at the same time if those supply problems last long enough.

If that happens, we're talking about 'stagflation'...

That's the phrase used to describe stagnant or slowing economic activity and accelerating inflation.

Last month, consumer prices rose 7% year-over-year... the highest increase in 40 years.

When the term stagflation was coined in the 1970s on the floor of the British House of Commons, persistent, high unemployment was also part of the definition.

To that point, today the comparison is not necessarily identical ‒ the unemployment rate is historically low at the moment ‒ but has a similar result, with fewer people working.

You see, labor-market participation is also near multidecade lows, signaling people just don't want to work.

Now, some argue stagflation is simply a byproduct of easy monetary policy, which makes sense. Don't ignore central bank and fiscal policy's role in higher inflation, not one bit.

Trillions of dollars created from thin air starting in March 2020 have made a lasting impact. And this is it...

When Federal Reserve policy gets tighter (higher interest rates, fewer asset purchases), it's done to slow economic growth in the U.S., which may or may not have been artificially stimulated by the central bank in the first place...

It's the same story with other central banks. As our Ten Stock Trader editor Greg Diamond wrote last week...

With inflation rising, the U.S. dollar is rising too, as the Federal Reserve is pulling back its monetary policy... which reduces overall U.S. dollars in the global economy versus flooding it after a crisis like the COVID lockdowns. So investors, especially overseas, see the dollar as more attractive versus their own country's currency.

It's simple economics really – if there is less supply of something and high demand, prices will rise.

When you are analyzing currencies, it's all about the relative value of one versus the other... Which currency has a higher interest rate and what are the expectations going forward for each country?

If inflation is still accelerating while the Fed is pulling back on stimulus, there you have the ingredients for stagflation.

Higher prices, a less valuable currency, and slower fundamental economic growth.

Recently, global organizations have started to warn about an economic slowdown...

On Thursday, the United Nations forecast lower economic growth for 2022 and 2023 to 4% and 3.5%, respectively... and the World Bank, which lends money to low- and middle-income countries, also reduced its growth outlook for next year.

According to the Associated Press, the U.N. said...

The world is facing new waves of coronavirus infections, persistent labor market challenges, lingering supply-chain issues, and rising inflationary pressures.

This was last seen most notably in the U.S. in the late 1970s...

Again, the employment situation was different. But at the very least, you could argue we're seeing shades of a "stagflationary" environment already...

Last month, U.S. retail sales declined more than expected...

We pay attention to how much business retail stores are doing because consumer spending makes up roughly 70% of economic activity...

As Stansberry NewsWire analyst Daniel Smoot reported on Friday...

According to the U.S. Commerce Department, retail sales fell by 1.9% in December. That's significantly lower than the projected decrease of 0.1%. This marked the U.S.'s first decline in five months, as the country largely reported gains in 2021.

Like November, Wall Street's concerns were primarily focused on the rapid spread of the Omicron mutation as well as inflation. While studies have come out suggesting that the variant is milder than anticipated, analysts remain concerned that consumer spending may see some disruptions over the short term – as governments around the world have reimposed travel restrictions and other mandates.

How long this environment lasts, nobody can know for sure. But two years on from the first reports of the "novel coronavirus," we never thought we would still mostly work from home.

Trends can go on longer than you think.

If Omicron is the last variant we have to deal with, then this entire discussion could be moot...

Frankly, I hope that's the case... Maybe enough people have been infected with COVID-19 worldwide that there's enough immunity out there to end the pandemic.

And maybe people will go back to working 9-to-5 in an office like they had been doing for their entire careers until March 2020... or like money wasn't dropped from the sky... or that governments didn't mismanage the crisis and confuse the public at every turn.

But I doubt it.

A lot of people retired and don't plan to come back to work... People trust government even less than they did before the pandemic, it seems.

And there's still time for new COVID-19 variants to emerge.

Thirty-six countries have vaccination rates of less than 10% of their population... Most of those are in Africa, though conflict-ridden countries like Afghanistan, Yemen, Syria, and Haiti are others.

If supply and demand of goods and services rebalance naturally around the globe, that would eliminate a great variable in the economy today... simply "what stuff is going to be available and when and for how much."

Anyone or any company that has answers for those two things has a big advantage today. That could be a company that supplies oil or other essential resources... or raw materials... or it could be simply a reliable worker too.

No matter what happens, the inflation cat is already out of the bag...

Some wages have gone up ‒ which after years and years of little to no growth is not a bad thing... But on the other hand, the price of diapers or toilet paper or milk isn't going to just go back down simply because companies could afford to lower them if supply-chain issues resolve themselves.

People are already buying at higher prices.

This is why we've repeatedly said that companies that have "pricing power" ‒ that can essentially charge what they want for their products ‒ are ones that can benefit the most during inflationary or stagflationary times.

I'm talking about companies like Starbucks (SBUX), which can sell addictive coffee without many people thinking twice about the price... or Hershey (HSY), which can do the same with chocolate bars... or how Google parent company Alphabet (GOOGL) can sell online advertising for more.

These are the companies that can keep their free cash flow high and growing and can afford to reward shareholders with dividends or generous stock buybacks that make fewer remaining shares more valuable.

Hard assets and commodities should continue to rise in relative value...

It's no surprise to us that, on a volatile trading day when virtually every asset in the global markets took a dip, the price of oil went up.

In fact, Brent crude oil futures, the international benchmark, hit a seven-year high today... So did the price of U.S. West Texas Intermediate oil.

Some of this could be attributed to geopolitical risks related to oil supply (a militant attack yesterday in the United Arab Emirates and concerns about a Russia-Ukraine conflict), but that's the point...

Supply worries would cause concern in "normal" times, but when they happen in a lower growth, higher inflation environment, the value of oil (or any other scarce asset) is heightened and can be distorted to the upside.

The price of gold could also be a beneficiary as sentiment around this "hard asset" grows... as it did immediately after the U.S. government's massive stimulus moves early in the pandemic.

Gold bulls have been on the wrong end of the trend the last 18 months or so, but a few of our editors see signs that could change soon...

Our DailyWealth Trader editors Ben Morris and Drew McConnell wrote about a bullish setup for gold in their issue last Friday, pointing out a favorable technical indicator and the fact that hedge-fund and other speculators are not overly bullish about the precious metal now.

That's a good "contrarian indicator," as Ben and Drew wrote...

Regular readers know gold is a precious metal that's used in bullion coins, bars, and jewelry... And it often climbs in price when folks are worried about the economy or the devaluation of paper currencies.

In the chart below, you can see that gold (the black line) hit an all-time high of $2,064 per ounce in August 2020. During that run, speculators piled on bullish bets (the blue line). And they were still extremely bullish (though less so) at the peak.

Then, as gold moved lower – falling about 18% to its March 8 low of $1,683 per ounce – they reduced those positions.

Now, gold has been bouncing around in a tighter and tighter range (called a "wedge," and shown on the chart with gold-colored lines). And speculator sentiment is back in neutral (not extreme) territory...

Speculators are often "wrong at extremes, but right in between." So this bullish-leaning sentiment is a positive sign for gold.

With growing economic and inflation worries, we expect gold to break out of its wedge to the upside. And if it does, it doesn't have the headwind of extremely bullish sentiment to hold it back from a big move higher.

While Ben and Drew did not recommend a gold trade just yet... they are prepared to if gold does break out to the upside.

Greg wrote in his Weekly Market Outlook yesterday that he's watching gold (and silver) closely right now for trading opportunities... and last week he analyzed the relationship between precious metals and the U.S. dollar.

On a related note, if you haven't already, be sure to check out more of Greg's thoughts on the markets in his "Crash 2022" presentation. The broadcast went live last Thursday and is available for replay here.

This global story isn't going away anytime soon...

Even if we don't see another major COVID-19 wave around the world, all these issues I'm writing about today aren't likely to disappear from economic data until at least the middle of the year...

Which means the Fed will probably be slow to act on what's happening now in real time. Until then, inflation is probably going to keep running high, even if rates tick a little higher.

Now, it's important to note that inflation could slow down too... That would be good news, but inflation rates, even if they dip a bit, will still be higher than many people ever remember seeing before the pandemic.

All the while, growth is going to slow and the value of tangible, in-demand goods and services will rise... Be prepared at the cash register or online checkout screen for higher prices and delays, and, as always, make sure you own high-quality stocks.

Be Your Own Central Banker

In this interview with our editor-at-large Daniela Cambone, Lynette Zang, chief market analyst at ITM Trading, shares her outlook for 2022... and why you should "become your own central banker" and own gold and silver in your portfolio.

"[Gold and silver] are the only financial assets in the world that run no counterparty risk," Zang says...

Click here to watch this video right now. For more free video content, subscribe to our Stansberry Research YouTube channel... and don't forget to follow us on Facebook, Instagram, LinkedIn, and Twitter.

New 52-week highs (as of 1/14/22): Applied Materials (AMAT), Berkshire Hathaway (BRK-B), CVS Health (CVS), Flowers Foods (FLO), General Dynamics (GD), General Mills (GIS), Hershey (HSY), Coca-Cola (KO), SPDR S&P Regional Banking Fund (KRE), Lam Research (LRCX), Mosaic (MOS), Invesco High Yield Equity Dividend Achievers Fund (PEY), Royal Dutch Shell (RDS-B), Suncor Energy (SU), Telekomunikasi Indonesia (TLK), United States Commodity Index Fund (USCI), and Viper Energy Partners (VNOM)

A quiet mailbag today. Let us know what's on your mind. E-mail us at feedback@stansberryresearch.com.

All the best,

Corey McLaughlin
Baltimore, Maryland
January 18, 2022