End of the 'Goldilocks' Economy

A Goldilocks economy describes an ideal steady state for an economy whereby the economy is not expanding or contracting by too much. A Goldilocks economy has predictable economic growth, preventing a recession, but not so much growth that inflation spikes.

Definition

A Goldilocks economy has an ideal growth rate of 2% to 3% as measured by gross domestic product growth. It has moderately rising prices as measured by the core inflation rate. The Federal Reserve has set this target inflation rate at 2%.

The little girl only ate the bear's porridge if was neither too hot nor too cold. Like the porridge, the Goldilocks economy is one that's "just right."

The term may have been created by David Shulman, senior economist of the UCLA Anderson Forecast, who wrote an article in 1992 called "The Goldilocks Economy: Keeping the Bears at Bay."

Why Goldilocks Economy has Worked

The goal for both the Fed's monetary policy and Congress' fiscal policy is to create enough demand to keep the economy humming at a healthy pace. The last decade saw low real interest rates and inflation that boosted asset valuations and revenue growth, despite relatively weak economic growth, also known as profit growth. As a result, stocks and bonds, and pretty much all asset with any semblance of risk performed well. The performance outliers to the upside were the assets with longer durations and negative earnings.

Recent Goldilocks History

To set the stage, the following periods depict notable recent notable Goldilocks economies.

• 2010: Obamacare was launched, helping the government to cut down healthcare costs. The Dodd-Frank Reform Wall Street Reform Act was enforced to regulate financial markets and to patch up the catastrophic failures of the banking industry in 2008.
• 2012: The U.S. was in an expansion phase, despite almost falling off a fiscal cliff that year.
• 2014–2015: The country was still in an expansion phase, with a strong dollar, low oil prices, and a steady, predictable rise in interest rates.
• 2017–2018: A weakened dollar and President Donald Trump’s tax plan boosted growth.

The U.S. has experienced 12 Goldilocks economies since 1956.

The Death of the Goldilocks Economy

The risk of slower growth, higher inflation and a geopolitical crisis brought about by the Russian invasion of Ukraine has taken a heavy toll on risk asset returns (especially technology) this year.

Signs of stagflation are evident as the yield curve is teetering on inversion, while real rates remain firmly perched in negative territory reflecting pessimism about economic growth in the medium run. These leading indicators are typically forebear an impending recession.

A Decade Already Lost?

Real rates remaining negative implies bond returns will be negative. And growth concerns and stagflation would imply stocks would get hit as well. Portfolio returns therefore will suffer. History suggests that such shocks can last for years, as has been seen in periods following World War I, II and the 70s where strong bull markets market by bubble territory valuations were followed by meagre market returns.

Last Word

If the Fed can thread the needle and avoid a stagflationary environment, markets should be fine and stock outperformance can continue once risk appetite returns. If this scenario does not play out, allocation to real assets with meaningful cashflows and high dividend will carry the day.

An extended period of low returns is a stark possibility in a rising rate, inflationary yet low-growth cycle.

Stay safe, stay nimble, stay humble!