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Economics: The 1970's Revisited
New York: August 21, 2006
By John R. Stephenson

It's starting to look a lot like the 1970's all over again. The 1970's was a decade where the stock market went nowhere, the economy was weak and inflation ravaged the landscape. It was also known as the decade where stagflation raised its ugly head. Stagflation is that condition where you have both rising inflation and a slowing economy. Could it be happening again? Who knows? But there are plenty of reasons to think that we could be in for at least a milder version of what investors saw three decades ago.

For starters, the July economic numbers have started to tumble out and industrial production in the U.S. has fallen to its lowest level in over a year. That's bad news not only for industry in general but also for supporting businesses, particularly technology firms that are reliant on the capital spending dollars of big industry. This data, coupled with weaker housing numbers, seem to be the early warnings of an economy starting to weaken.

On the bright side, this past week showed a weaker than expected producer price index (PPI-a measure of wholesale inflation) and consumer price index (CPI). Still, there are plenty of reasons to worry about rising inflation. Namely oil prices. But while oil prices have moderated somewhat from their peak a few weeks ago, they remain stubbornly high with no end in site.

While demand for oil remains strong, supply continues to struggle. Not only that, but demand growth is coming from all over. During the 1970s, struggling supply conspired to drive oil prices upward. Today, supply is once again struggling and demand is strong and coming from all four corners of the globe. China and India, once bit players in the world of oil, are now at the forefront.

These emerging economies are likely to play an increasing role in the demand for oil and base metals (copper, nickel and zinc) for decades to come. Unlike the industrialized west, China and India are coming off a very low base of per capita use. Not only is the oil and base metal usage low on a per capita basis, but these are enormous countries where much of the current economic miracle is yet to be experienced by many of their citizens.

Figure 1: China is Now the Second Largest Consumer of Oil in the World

Source: CIBC WM


Figure 2: In Base Metals the Story is Much the Same

Source: CIBC WM


Growth is what China is all about. Just last quarter, China's economy grew at a staggering 11.5% while our own, although still growing, is beginning to falter. Over the past 5 years, the U.S. has been responsible for just 15% of the total global economic growth raising the alarm that the U.S. may no longer be the heart of the global economic engine.

If it is true that other economies are beginning to supplant the U.S. as the global economic leader, then we could be in for some tough sledding ahead. Stagflation, the condition of rising prices (through higher energy prices) and stagnant economic growth could, in a mild form, be already upon us.

So, what's a savvy investor to do? For starters, consider what worked in the 1970's. Commodities, and the stocks of commodity producers worked like magic where the broader stock market went nowhere.

Think commodities are dull and boring? Just consider this: between 1969 and 1982, commodities soared. Corn increased in value 295 percent. Sugar moved some 1,290 percent between 1969 and 1974 and oil increased in price some 15 times during the 1970's. Could it happen again? Quite possibly, in part because we have so many new players, in addition to the older players, competing for scarce resources.

According to academic research published by the Yale International Center for Finance, returns from commodities were "negatively correlated" with equity and bond returns. In other words, commodities and the equities of commodity producers zig when bonds and the broader equity market zags.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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