(Clarifies paragraph 2)

By Jamie McGeever

ORLANDO FL (Reuters). Despite rising prices and slower economic growth, many investors have turned to the past to predict where U.S. stocks might head next. The 1970s “stagflation”, which brought back many memories, may inspire investors to look at the mid 2000s.

     In both periods energy prices, inflation expectations and bond yields rose, alongside anemic growth and central banks moving toward tighter monetary policy. However, the mid-2000s saw a much more mild market.

    While all economic and market cycles are unique – none more so than the last 18 COVID months of recession, rebound and inflation caused by supply bottlenecks and shortages – the conditions that exist today are more akin to the ones that occurred in 2005.

    Like 2005, U.S. equity valuations are now gently falling. The S&P 12-month forward price/earnings ratio is now around 20.5, down from over 23 a year ago, mirroring the decline to 14 from 16 over the course of 2005.

    That downward drift continued into 2006. The trend downward continued in 2006.

    The experienced two mini-corrections in 2005, the first of 8% in March-April and then a 6% drawdown in September-October. According to almost two-thirds (of more than 600 market professionals) who were surveyed recently, the index experienced its first 5% decline in nearly a year. Deutsche Bank (DE): A correction of 5% to 10% by year end is on the cards.

    Some analysts have started to point to the mid-2000s as a possible case study. Morgan Stanley Andrew Sheets of the NYSE wrote on Sunday, “an interesting, recently example of an stagflation panic after a midcycle transition.”

    CALM OR COMPLACENCY?

    In some key respects, the inflation picture is more akin to 2005 than the 1970s, too.

    Headline annual inflation is now just above 5%, the highest in 13 years, compared with a peak of just below 5%, a then 14-year high. The double-digit print of the late 1970s and mid- to late 1980s that saw a severe wage-price spiral is not evident.

    Inflation of the 1970s is rightly associated with energy shocks and shortages. In the mid 2000s, however, there was a significant increase in oil and natural gasoline prices. This led to a wider rise in consumer price. As today.

    more than doubled to $65 a barrel by the end of 2005 from around $30 at the beginning of 2004. The price has more than doubled to $83/barrel in the past 18 months, and it will be testing $100 according to an investor survey by Deutsche Bank.

    U.S. recently hit a 12-year high above $5.565 per million British thermal units after a near-40% spike in just six weeks. Between July and August 2005, the natgas price rose by around half to record levels, reaching just under $14/mmBtu.

    There’s no doubt investors and policymakers must be vigilant as inflation expectations measured by breakevens rise across the curve toward May’s multi-year peaks. That’s about 2.80% for the U.S. 5-year rates. The last time that it exceeded that level was 2005.

    Call it calm or complacency, but Wall Street appears relatively relaxed. The of implied volatility on the S&P 500 has mostly traded below 20 since March, suggesting equity markets are broadly comfortable with expected higher future levels of inflation, interest rates and bond yields.

    As Morgan Stanley’s Sheets points out, inflation markets imply that price pressures will moderate over time, rather than spiral. Additionally, equity valuations have reached all-time highs and nominal interest rates remain low.

    In the 1970s, the opposite of all that held true.

    “If ‘stagflation’ means ‘the 1970s,’ a time of wage-price spirals and high unemployment, this clearly isn’t it,” he said.