Embrace Stagflation in Your Portfolio

Stocks were up this morning, but the small-cap Russell 2000 entered official correction territory on Friday, and the S&P 500 was down some 7% from its recent highs. That said, it is hard to find much value in the overall market with the Shiller price-to-earnings ratio still around 37.5. That is about ten points higher than 2007 when subprime problems started to crop up and mortgage funds started to “gate” redemptions.

History may not repeat, but it tends to rhyme, as Mark Twain would say. This time it is private credit that is the epicenter of the worries within the credit markets. Major private credit funds run by the likes of Cliffwater and Blackrock (BLK)  are gating some investor redemption requests. JPMorgan Chase & Co. (JPM)  is pulling back credit to the space and marked down some private credit loans. I would expect other major banks to implement similar actions. One would think given the headlines, redemption requests from private credit funds will accelerate.

This could lead to a bit of credit crunch for the mid-market firms that rely on these loans. And this is not the only new headwind small and midsize companies are now facing thanks to the latest conflict in the Middle East. Surging oil prices have garnered the lion’s share of financial bylines. And it should be noted that Europe and Asia are in much worse shape due to the cut-off of oil exports from the Strait of Hormuz. Which is why Brent and WTI oil benchmarks have a historically large divergence.

That said, the impacts are already being felt in the States. The most notable near-term impact for consumers is that gasoline prices are already heading to four bucks a gallon. That’s the last thing the struggling U.S. consumer needed right now. Consumer sentiment was already in the tank, pun intended, before this new pain at the pump.

Importantly, diesel has moved past five bucks a gallon for the first time since 2022. And given the rail and trucking industries dependence on this fuel, this means extra costs for just about every item that needs to be transported to its destination. This means higher costs for consumers and lower profit margins for many businesses as well. In addition, fertilizer prices have soared since the opening of this new conflict as well. This will push food inflation higher.

Surging commodity prices have pushed interest rates higher with the yield on the 10-Year treasury yield to nearly 4.4%. The yield is quite a bit higher than where it stood before the Federal Reserve started to take down the Fed Funds rate by a cumulative one-and-three-quarters percentage points in September. Any near-term cut to rates is off the table now. Higher interest rates are a headwind to businesses, consumers and the already moribund housing sector.

Related: The Market Is Hit With a TACO and Likes It

The U.S. economy lost 92,000 positions last month according to the February Bureau of Labor Statistics report. Higher energy, commodity, food and transportation costs are hardly a harbinger for increased hiring, especially as businesses already faced concerns around tariff policies and other key worries.

Higher inflation and flat or negative job growth is a recipe for Stagflation, whose likelihood has increased substantially over the past three weeks. And even with the recent declines in the market, equities are not closed to being priced for that scenario. If the Strait of Hormuz remains effectively closed for much longer, stocks have another leg down especially if more cockroaches appear in the credit markets. And this is why prudent investors should view the next few weeks with trepidation and caution. Things could well get worse before they can get better. Let’s see if this boost in the market turns out to be just relief rally that fades quickly….

At the time of publication, Jensen had no position in any security mentioned.Â