Should Investors Worry About the Potential for Hyperinflation or Stagflation?

Investors have been hearing a lot about hyperinflation, stagflation and deflation of late, but what’s the likeliest scenario going into 2022?

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Hyperinflation and stagflation are some pretty scary terms that are being thrown around of late. Undoubtedly, they both represent extreme scenarios, both quite horrific. With Square‘s CEO Jack Dorsey recently warning about the potential for “hyperinflation” and its potential to “change the world,” many investors would be better served by taking a step back to consider the most plausible outcomes.

Indeed, Dorsey is a brilliant mind in the world of tech. As for his abilities to forecast macroeconomic trends, I’m not so sure he’s on the spot. In any case, hyperinflation would be a boon for cryptocurrencies and fintech firms such as Square that could stand to benefit from the acceptance of such speculative tokens.

While inflation is on the high end, investors shouldn’t panic over the possibility of hyperinflation or Dorsey’s ringing of alarm bells, especially given the many disinflationary forces that are still likely at work. Which disinflationary forces are they?

ARK Invest’s Cathie Wood highlights three main ones, technological innovation driven by tech leaders like Shopify, firms’ stockpiling of goods, and product obsolescence resulting from firms that refuse to invest in innovation. Undoubtedly, all three factors could apply downward pressure on prices over the next few years. And as supply chain issues are resolved, the case for “transitory” inflation seems to be the likeliest scenario.

While I wouldn’t bet on deflation happening anytime soon, as someone like Cathie Wood may expect on the opposite extreme of the likes of a Jack Dorsey, I would stay the course and take any extreme, alarm bell-ringing predictions about where inflation could head next with a very fine grain of salt.

What’s next? Hyperinflation, stagflation or deflation?

Currently, I believe Wood and Dorsey, who both have extreme opposite views of inflation’s next steps, are unlikely to be proven right. Instead, U.S. Fed chair Jerome Powell will probably end up being right, with inflation proving to be transitory, with disinflationary forces pushing the rate of inflation closer to that 2% target.

Given COVID disruptions, inflation could remain slightly on the higher end of the target range at around 2-3% over the medium term. As the pandemic goes endemic, expect disinflationary forces outlined by Cathie Wood to drag inflation closer to the 1% mark. And, of course, deflation can’t be ruled out over the longer term.

Between the two extremes, I think deflation is far likelier than hyperinflation despite the recent spike. However, the most plausible scenario is modest disinflation that brings inflation closer to the Fed’s target. Indeed, Powell and his “transitory” inflation view seem far likelier than Dorsey’s hyperinflation or Wood’s deflation.

What about stagflation?

Earnings growth is starting to slow, and if inflation stays elevated at these levels, some fear a 1970s repeat could be up ahead. Again, the extremely bearish scenario seems unlikely, given disinflationary forces that could present themselves at some point over the next 18 months.

Indeed, technological innovation has been given a jolt amid the COVID crisis. And in due time, I do think the Fed will be proven right. Moreover, a modest slowdown in economic growth is only expected in a transition into its mid-cycle. That doesn’t necessarily mean that the bull market is entering old age or that it’ll be on life support through the 2020s. A “Roaring 20s” environment is still very much possible. Of course, recent bumps in the road are to be expected en route to the stock market’s move to higher levels.

In short, there may be nothing to fear over the long haul but inflation fear itself

Hyperinflation and stagflation are scary. But neither seems likely at this juncture, given the profound disinflationary forces that could make an appearance as soon as the first half of 2022. As such, investors shouldn’t take drastic action with their portfolios in response to any bear-case scenario. Instead, one should stick with quality firms at solid prices. Names like Shopify could continue raising the bar higher on the innovation front.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Joey Frenette has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Shopify and Square. The Motley Fool recommends the following options: long January 2023 $1,140 calls on Shopify and short January 2023 $1,160 calls on Shopify.

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