May 10, 2022 - 3:00pm

Warren Buffett once said that when the tide goes out, we see who was swimming naked. The market sell-off that has taken place over the past few weeks has revealed more than a little nudity.

The most striking thing about the sell-off is how broad it is. Most markets seem to have taken a hit, but the sell-off seems mostly driven by the tech sector. The NYSE FANG+ index, which tracks the biggest tech players, is down just under 35% from the start of the year. The broader tech heavy NASDAQ is down just shy of 27% in the same period.

But the sell-off has spread to other markets too. Bitcoin is down just over 27% this year. Gold is up since the start of the year, but it has taken a beating since March-April. Most interestingly, bonds have fallen too; a typical ETF that allows investors to get exposure to the US treasury market is down around 6.5% since the start of the year.

This wasn’t supposed to happen: when stocks go down, bonds are generally supposed to go up. This is why investment advisers tell investors to hold a mixed portfolio of bonds and stocks. The bonds are supposed to provide a sort of insurance for when the stock market hits the wall.

The fact that bonds and stocks are moving together is indicative of a much broader problem: namely, inflation and the possibility of stagflation (low growth and inflation). Typically, investors assume that inflation happens when growth is high, but today we are seeing high inflation and low growth.

In the first quarter of 2022, the US inflation rate was 8% while real GDP shrank by 1.4%. Markets had long been discussing the possibility of stagflation taking hold but seeing such poor GDP figures last week while inflation is so high caused a freak-out in the markets.

The situation does not seem great. After months of lockdowns, our politicians have found new reasons to intervene aggressively in our economies, and this is provoking the stagflation monster — the war in Ukraine seems to have provided them with a blank cheque on clumsy interventions. Given that inflation tops the polls in terms of voters’ concerns, I find some of these actions hard to understand.

We cannot call stagflation definitively yet. We need to see what happens in the coming months, but it certainly looks like a possibility. In such an environment, those who hold savings are going to get punished. There is simply no guaranteed asset class available that guarantees tangible investment returns in this sort of climate.

What about the real economy? Those with large stock portfolios will feel the pain of these losses. This can pass through to consumption — a phenomenon economists call the ‘wealth effect’. But with inflation raging, people will also want to offload their decaying cash and buy products before the prices rise even higher. Unfortunately, the next few months are going to be very rocky indeed.

Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics