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Inflation Time Machine: A Journey from the Swingin' Forties to the Disco Seventies and Beyond
The economic landscape evolves under the influence of
various factors that shape the course of history and the
financial markets. Inflationary environments during different
eras have been marked by distinct features and influential
factors, teaching valuable lessons that apply today.
This edition of our monthly publication takes you on a
journey through the inflationary episodes of the 1940s, the
1970s, and the present day, offering insights into how
exogenous shocks, goods and services inflation, and wage
dynamics have evolved within the U.S. economy. Even though
the primary focus is on the United States, many of the
conclusions apply to other developed markets, such as
Canada. By examining these patterns in depth, we can better
understand economic trends and navigate the constantly
changing financial world that defines our contemporary
Exogenous Shocks: Comparing the 1940s, 1970s, and Today
The inflationary environments of the 1940s and the 1970s
were largely driven by single, significant exogenous shocks. In
contrast, today’s inflationary pressures are more complex,
resulting from a combination of factors.
In the 1940s, the Second World War emerged as the principal
catalyst for inflation. The war sparked a massive increase in
the demand for raw materials, labour, and equipment,
placing substantial strain on global supply chains.
Additionally, governments implemented various price
controls and rationing measures, further contributing to
supply shortages and driving up prices. In the post-war years,
pent-up consumer demand and wage hikes fuelled inflationary pressures. Overall, the exogenous shocks during
this period were due primarily to the wartime economy.
The 1970s brought another major exogenous shock – the
OPEC oil embargo. With oil prices quadrupling almost
overnight, the effects reverberated throughout the global
economy, especially in developed nations reliant on imported
oil. Consequently, businesses faced increased production
costs, which they transferred to consumers. Furthermore, the
price hikes spurred wage-price spirals, as workers demanded
higher wages to cope with rising living expenses, exacerbating
inflation even more
In contrast, the current inflationary environment isn’t driven
solely by a single, powerful exogenous shock. Instead, it is
due to various factors, such as global supply-chain disruptions
caused by the COVID-19 pandemic, fiscal stimulus measures,
and an uneven economic recovery. This blend of demandand supply-side pressures has led to a more intricate
inflationary landscape, where multiple elements interact with
and influence one another.
Goods versus Services Inflation:
Comparing the 1940s, 1970s, and
The disparities in goods and services inflation in the 1940s,
the 1970s, and the present day highlight the shifting
dynamics of the global economy, government policies,
consumer behaviour, and exogenous factors over time.
1940s: Balanced Inflation
In the 1940s, goods and services inflation manifested itself
more evenly. The world was grappling with the Great
Depression’s aftermath, and the Second World War
demanded massive resource reallocations. The balanced
nature of goods and services inflation during this period can
be attributed primarily to the broader economic challenges
and the transition from a wartime to a peacetime economy.
1970s: Goods Inflation Outpaces Services
The 1970s saw a notable divergence between goods and
services inflation, with goods inflation escalating to 10.3% in
1973. The primary driver for this stark difference was the
OPEC oil embargo, which dramatically raised production costs
as oil prices quadrupled. Businesses passed the increased
costs on to consumers, leading to higher goods prices.
Meanwhile, services inflation registered a lower rate, at 6.4%,
because it was less directly affected by the oil crisis.
Present Day: Services Inflation Takes the Lead
In today’s economic climate, services inflation has overtaken
goods inflation, with service prices now standing at 5.16% a
year versus a 1.4% increase in goods prices. The primary
catalyst for this reversal is the COVID-19 pandemic, which has
dramatically altered consumer behaviour and spending
patterns. As lockdowns and social distancing measures forced
people to limit purchases of non-essential goods, they
pivoted to services, particularly in the digital realm. This
demand shift caused a surge in prices for various services,
such as streaming platforms, online education, and
telemedicine. Consequently, the current economic
environment exhibits a significant departure from past
inflationary episodes, with services inflation assuming a more
Wage Inflation Dynamics: Elaborating
on the 1940s and 1970s
The wage inflation spirals of the 1940s and 1970s were
influenced by the unique economic, political, and social
contexts of those times. To understand the underlying
mechanisms driving these wage-inflation dynamics, it is
essential to delve deeper into the specific conditions that
shaped the two decades.
1940s: Complex Post-War Wage Pressures
The wage inflation spiral of the 1940s was shaped
predominantly by the aftermath of the Second World War.
The complex interplay between several factors contributed to
the upward pressure on wages and inflation during this
period. Labour-market shifts occurred as military personnel
returned to civilian life, substantially expanding the labour
force and altering the skills landscape as women who had
entered the workforce during the war were displaced amid
the conversion of plants from military to civilian use.
Government interventions during this period played a
significant role in shaping wage dynamics. For example, the GI
Bill provided financial support for education, housing, and
business opportunities, affecting labour-market conditions
and wage prospects. Furthermore, the strength of labour
unions played a crucial role in wage pressures, with union
membership soaring to more than 14 million workers in 1945,
or about 35% of the non-agricultural workforce. This surge in
membership led to collective bargaining agreements and
strikes, further influencing the inflationary environment.
Despite these seemingly powerful drivers, the wage-inflation
spiral in the 1940s was relatively contained, with wage
growth peaking at an annualized rate of 14.4% in 1947. The
strong focus on rebuilding and recovery across industries and
the continued presence of government interventions,
including price controls and rationing systems, played a
1970s: Oil Crisis and Escalating Wages
The wage-inflation spiral of the 1970s was markedly different
from the previous decades, largely because of the OPEC oil
embargo and its far-reaching impact on goods prices and the
cost of living.
As businesses faced higher production costs due to soaring oil
prices, they passed the costs on to consumers, causing a
significant spike in goods prices. For example, U.S. consumer
prices for goods increased by an average of 7.4% a year from
1973 to 1982. In response to spiralling costs, workers
demanded increased wages to maintain their standard of
A prime example of the wage-inflation spiral was the 1974
coal miners’ strike in the United Kingdom, which resulted in a
35% pay rise and contributed to the inflationary spiral. The
settlement elevated the base for wages, which then
contributed to a self-reinforcing cycle of rising wages and
Persistently high inflation during the 1970s led to widespread
expectations of continuing inflation. Consequently,
businesses and workers factored these expectations into their
wage- and price-setting decisions, further perpetuating the
wage inflation spiral. In 1980, annual inflation peaked at
13.5% in the United States.
Government measures to address inflation during this period,
such as monetary and fiscal policies, as well as attempts to
regulate wages and prices, were largely unsuccessful. Often,
these policies led to unintended consequences, such as
stagflation (a combination of stagnant economic growth, high
unemployment, and high inflation), or they were met with
public resistance, adding to the challenge of containing
Current Wage-Inflation Dynamics
The current wage-inflation dynamics present a unique and
complex situation compared with the historical episodes of
the 1940s and 1970s. Several factors contribute to the
evolving landscape, highlighting the multifaceted nature of
today’s economic environment.
First, the COVID-19 pandemic temporarily disrupted labour
markets around the world, leading to widespread job losses
and furloughs in severely affected industries, such as leisure
and hospitality, retail, and tourism. In contrast, some sectors,
such as e-commerce, health care, and technology, saw an
increase in demand for workers, resulting in upward pressure
The pandemic has also accelerated the adoption of remote
work, allowing employees to work from home or to relocate
to more affordable areas while retaining their jobs. This shift
has altered the dynamics of labour supply, giving companies
access to a wider pool of talent across different regions and
potentially increasing the bargaining power of workers and
their wage demands.
Governments around the world have implemented various
measures to support workers and businesses during the
pandemic. Programs such as unemployment benefits, wagesupport schemes, and direct cash transfers have temporarily
mitigated the downward wage pressures caused by the crisis.
Even so, the phased withdrawal or termination of these
programs might create new labour-market dynamics and
As the economic landscape continues to evolve, the demand
for some skills increases while others become obsolete. This
skills mismatch, coupled with the rise of automation and
artificial intelligence in various industries, can further
influence wage dynamics by creating shortages of highly
skilled labour, leading to increased competition for such
workers and higher wages.
Lastly, the recent uptick in inflation, driven by factors such as
supply-chain disruptions, pent-up consumer demand, and
fiscal stimulus, has prompted concerns about rising inflation
expectations. If businesses and workers begin to expect
higher inflation, this mindset may become ingrained in wage and price-setting decisions, potentially contributing to a
Concluding Remarks on Inflation
When comparing the inflationary periods of the 1940s, the
1970s, and the present day, we can see clearly that each era
is marked by distinct characteristics and factors. Even though
the United States serves as the primary focus of this analysis,
the general conclusions apply to other developed markets.
Recognizing these differences is crucial as we navigate the
current inflationary environment and adapt our financial
The current inflation bout notably diverges from that of the
1970s, which was characterized by the OPEC oil embargo and
ensuing wage-price spirals. In contrast, today’s inflationary
pressures are multifaceted, resulting from a combination of
global supply-chain disruptions caused by the COVID-19
pandemic, fiscal stimulus measures, and an uneven economic
recovery. This complex interplay of factors distinguishes the
current inflation scenario from the historically significant,
exogenous, shock-driven inflation of the 1970s.
Moreover, the changing dynamics of goods and services
inflation, as well as the evolving wage inflation landscape,
further emphasize the distinct nature of today’s economic
environment. By acknowledging these differences and
learning from the challenges faced during the 1940s and
1970s, financial professionals and market observers can
develop a more comprehensive understanding of current
inflationary pressures and craft informed strategies to
The macroeconomic environment remains a risk factor as the
lagged impacts of monetary policy continue to make their
way slowly into the economy and markets.
The manufacturing sector is already in a recession and
recently seems to have bottomed. That being said, between
the ISM manufacturing index is a leading indicator of both
sales and earnings growth on the S&P 500 Index, and the
historical relationship is too tight to ignore.
The relationship between the performance of the global
stocks/bonds ratio also hinges on the behaviour of the global
manufacturing cycle, and, although the macro data have
recently taken a turn for the better, we continue to reserve
our judgment before calling a bottom, at least until we clear
the hurdle caused by the short-term, ultra-stimulative fiscal
policy in the United States.
Still, our integrated framework makes use of our macro views
and combines them with other important factors, such as
momentum, valuation, and sentiment analysis. Even though
our macro views are not conducive to risk taking, the picture
is a bit more constructive on a tactical level from momentum
In terms of momentum,
1 our framework paints a diverging
Starting with the U.S. indexes, we see that short-term trends
have turned negative on every index, while the long-term,
slow-moving trends remain positive. The medium-term trend
is diverging between the NASDAQ and the S&P 500, with a
more negative signal on the latter.
Outside the U.S., we note that momentum signals are
generally negative on every window, with the Nikkei and
EAFE indexes sending a few positive signals on the medium
and/or slow components. Overall, even though momentum
has led our positioning to be more favourable to global
equities in previous months, the deterioration of most trends
is arguing for a reduction in equity exposure.
Turning to valuation, we get mixed signals, depending on
geographies. As can be inferred from the table below, the
large cap U.S. indexes are considered on most metrics to be
expensive on a historical basis, with median 10-year
percentiles of 71% on the S&P 500 and 77% on the NASDAQ,
far ahead of Canada (11%), EAFE (7%) and Japan (20%). In the
United States, small caps remain inexpensive as the median
percentile is among the lowest listed below, at 8%.
Emerging markets are more of a mixed bag, with the median
percentile sitting near the mid-point, at 44%.
Finally, we see the large footprint of U.S. equities in the global
indexes; the MSCI World and ACWI indexes show median
percentiles of about 50%.
Turning to sentiment, we note that investor perception has
shifted wildly over the past year, from strongly negative to
strongly positive, as shown by both the AAII sentiment survey
and the well-followed JP Morgan Global Equity Sentiment
Investors’ current positioning also seems to be more neutral,
with the VIX index still hovering around the 20 level. All in all,
this suggests a more balanced picture on sentiment, with the
recent signs of excess enthusiasm from retail investors having
Wrapping up equities, we note that our macro signals and
momentum do not tell a compelling story for risk taking, but
valuations and sentiment combine to advocate for a less
defensive positioning outside the large U.S. indexes.
North American long rates continued their upward trend in
October, with gains of as much as 30 basis points in a single
week at mid-month.
The recent revisions to expected growth (the soft-landing
scenario, which we don’t adhere to, continues to gain
traction among investors), expected inflation (geopolitical risk
premium amid the flare-ups in the Middle East), and the term
premium (investors now hearing the higher-for-longer
message from central bankers) all played a role in pushing the
U.S. 10-year rate to 5% for the first time since 2007.
Our macro framework is sending convincing signals to
overweight sovereign bonds and duration. Given how
prevalent the soft-landing narrative is and our view that the
negative effects of monetary policy tightening on growth are
still unfolding, we expect negative growth and inflation
surprise to hit investors in the coming quarters, which should
push long sovereign rates lower.
Turning to momentum, we have to acknowledge that the
recent trends have been quite unfavourable, but the fast
signals are getting better on both sides of the border, as
market rates have crept up to 15-year highs. The road to the
current levels has been bumpy, and we never know when
such impressive, sustained moves will occur, so we’ll keep our
eyes on the behaviour of the fast and medium signals before
definitely calling for a reversal in momentum.
From a valuation perspective, sovereign bonds have become
Even though it is generally tricky to come up with a fair value
measure of interest rates, we are firm believers in long-term
relationships as investment guides. Looking at the historical
returns on 10-year U.S. bonds, we find (using the Bogle &
Nolan model) that the main determining factor in long-term
returns is simply the prevalent rate at the time of purchase,
meaning that capital gains tend to be of lesser importance
over time (chart).
Current valuation doesn’t tell us anything about the expected
short-term performance of sovereign bonds but it does tell us
that, on the basis of this tight historical relationship, the
current entry point seems better than at any other time in
the past 15 years.
Turning to corporate bonds, we see that spreads on IG and HY
bonds remain tight compared with previous recessionary
periods, indicating that the space is either cheap or expensive
depending on the economic outcome of 2024.
As our macro framework continues to point to risks of a mild
recession in the coming quarters, we are inclined to conclude
that spreads should be wider, especially for HY bonds, leading
us to take a clear underweight position.
Regarding IG bonds, our positioning so far this year has been
to remain slightly overweight, given how resilient spreads
have been amid strong institutional demand for high-quality
paper. We also know from history that HY spreads widen
much more than IG spreads in a recession, adding to the
opportunity for a long/short trade that could be beneficial if
the macro landscape deteriorates.
Finally, looking at investor sentiment, we note that the MOVE
index (representing the bond market’s implied volatility)
continues to stick out and to suggest ample nervousness in
Even though this nervousness is not surprising, given how
violent the recent repricing of the bond market has been, it
does continue to suggest that a contrarian long positioning
makes sense. The JP Morgan Client Survey Indicator also
sends a positive signal that institutional investors remain net
Last, the put/call ratio on 10-year U.S. Treasuries moved
above 1 in the past month, but seems to have turned the
corner, indicating less appetite for protection and emerging
positive views on the asset.
Overall, even though momentum has clearly not been
favourable to an overweight in fixed income in general so far
in 2023, the convincing signals from our macro, valuation,
and sentiment analysis combine to support an overweight
position, mostly in high-duration sovereign bonds and IG
corporate bonds, and a significant underweight in lowerquality HY bonds.
Commodities and Foreign Exchange
Heightened tensions in the Middle East have already
increased the geopolitical risk premium on crude oil, and
could add further upside to global oil prices, depending on
how far the current conflict spreads. This context makes fossil
fuels an even more attractive asset class in the short run,
while also making the macro picture, inflation expectations,
and the outlook for base metals more blurry, given that
higher energy prices can be a drag on global growth.
After our comments from last month regarding the potential
for commodities to outperform U.S. equities in the coming
months, the news flow in October only reinforced our view,
mostly from the perspective of higher oil prices.
Our momentum analysis framework suggests that oil and
gold are favored in the short-term, with gold also posting a
long-term uptrend. Copper, on the other hand, remains out
Our sights this month are turning to gold.
Gold had an interesting rebound in October in response to
the Israel-Gaza situation, playing its role as a geopolitical
diversifier in portfolios. The jury is still out about the potential
for more gains, given the rise in real rates and the U.S. dollar,
but it does seem that the yellow metal continues to have a
niche despite the emergence of crypto currencies.
The recent relative performance of gold versus other asset
classes is once again informative in that the asset class forms
an essential component of a well-balanced portfolio in times
of geopolitical turmoil. Gold outperformed not only U.S.
equities but also the overall commodity basket in October. As
the geopolitical situation in the Middle East remains fluid, and
gold has only begun to react, we will be looking for a good
entry point in gold in the coming month, which could come
from a short-term pullback or a convincing break through the
recent resistance levels.
Looking at foreign exchange, we see that the strength of the
U.S. dollar has been massive over the past 6 months, and
momentum on the Canadian dollar is negative across all
windows. The euro still seems to be favoured by long-term
momentum, but the deterioration of the fast and medium
components bodes ill for holding a positive view. The signal
from momentum is clear: don’t fight the trend (yet) on the
Finally, the loonie is still struggling to find its footing despite
the resilience of oil prices. It seems that, for now, the worries
surrounding the global economic cycle are pushing capital
flows toward the U.S. dollar as a safe haven, and that quite
likely a seeming bottom in global macro data or a flare-up in
oil prices will be needed to restore an upward trend on the
Still, as stated repeatedly in previous publications, we are of
the opinion that, given the resilience of the Canadian
economy, the loonie could be one of the quickest currencies
out of the gate when we finally see the start of a brand-new