Graphic: The specter of stagflation
Inflation has persisted for much longer than the Federal Reserve anticipated, due to supply shocks from Russia’s invasion of Ukraine and the aftereffects of the pandemic. That has caused some economists and market strategists to question whether the U.S. economy could return to a 1970s-like era of stagflation, and potentially fall into a recession. Should that occur, equity returns would likely drop further.
Eroding returns: The S&P 500 index had negative real returns from 1972 to 1976 and 1977 to 1981, when annualized inflation was 7.3% and 10%, respectively. The only other period in which a negative real return occurred in the past 50 years was 2007 to 2011, during the Great Recession.
S&P 500 returns and inflation
Lower earnings multiple: Rising inflation and the S&P 500’s price/earnings ratio have been negatively correlated. Since 1970, there is a -0.56 correlation between annual inflation rate and the P/E ratio.
P/E ratio and inflation
Cherry-picking sectors: The S&P 500’s Q1 operating margin contracted by about 110 basis points from a year ago. However, some sectors, such as energy, have done better than others during high inflationary periods.
Operating margin by S&P 500 sector
| Q1 2021 | Q2 2021 | Q3 2021 | Q4 2021 | Q1 2022 | |
|---|---|---|---|---|---|
| S&P 500 | 13.0% | 13.5% | 13.2% | 13.4% | 11.9% |
| Energy | 4.0% | 6.1% | 9.0% | 10.4% | 11.0% |
| Real estate | 17.9% | 23.2% | 22.3% | 24.3% | 21.0% |
| Materials | 11.0% | 14.3% | 12.8% | 12.2% | 13.6% |
| Industrials | 6.8% | 9.4% | 9.5% | 8.5% | 7.8% |
| Information technology | 22.0% | 22.4% | 23.6% | 24.4% | 23.0% |
| Consumer staples | 7.2% | 8.0% | 7.8% | 7.3% | 7.1% |
| Health care | 10.0% | 9.6% | 10.6% | 9.0% | 9.4% |
| Utilities | 14.6% | 11.5% | 14.8% | 8.5% | 12.9% |
| Communication services | 19.2% | 18.5% | 17.9% | 16.8% | 16.0% |
| Consumer discretionary | 7.9% | 8.2% | 7.3% | 8.6% | 4.3% |
| Financials | 24.4% | 25.3% | 20.3% | 24.0% | 17.9% |
Low energy: Although energy’s performance has been an outlier this year, it represents less than 4.5% of the S&P 500. Information technology is the index’s largest sector, at about 27%, but sluggish economic growth might weigh on the sector’s profitability.
S&P 500 sector weights
Sources: Bloomberg LP, Federal Reserve Economic Data, Department of Labor Statistics, S&P Dow Jones Indices
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