Are We In A Goldilocks Economy?

Key takeaways

• In light of moderating economic data, some economists believe we could be headed toward a “Goldilocks economy” – or in one already
• Goldilocks economies are “just right,” with enough growth to stave off recession without soaring inflation
• Investors can profit in Goldilocks states as companies enjoy steady growth while consumers can afford the occasional splurge

Last week, the Labor Department released its August jobs report. The numbers, though exceeding expectations, fell short of July’s stratospheric performance with some 315,000 jobs added. At the same time, more workers entered the labor market, slightly increasing the unemployment rate from 3.5% to 3.7%.

Yet the news isn’t all good.

Inflation remains high amid Covid lockdowns in China, Europe’s brewing energy crisis, and ongoing supply chain snarls.

The housing market may be on the cusp of recession as demand (and prices) cool.

And experts say that the Fed could hike rates anywhere from 0.5% to 1% in September depending on inflation data.

Yet, these factors – alongside slowing but still-positive corporate profits – have some economists suggesting we could be enjoying a “Goldilocks economy.”

But…why?

What is a “Goldilocks economy”?

A Goldilocks economy is an economy that is experiencing “just right” levels of growth. It’s not too hot to suffer runaway inflation, but not so cold that unemployment spikes.

During Goldilocks periods, employment remains robust, growth is stable (but continuing) and the economy chugs along, rather than slams full steam ahead. In other words, consumers and businesses flourish absent huge expansions or contractions.

It’s believed that economist David Shulman first coined the phrase in his 1992 article “The Goldilocks Economy: Keeping the Bears at Bay.” At the time, the U.S. economy was “not too hot, not too cold, but just right” – ideal for all market participants.

Other Goldilocks periods include the post-dot-com bubble burst recovery between 2004-2005 and the low-inflation, 3% GDP growth period in 2017.

Common features of Goldilocks economies

Peter C. Earle, an economist at the American Institute for Economic Research, explains a Goldilocks economy as a growing economy in which “the purchasing power is stable, wages [are] rising and more goods and services [are] available. The idea here is that…we have growth but with minimum or no inflation and maximized, to the extent possible, employment.”

Still, economists tend to debate exactly what that looks like. What is agreed upon is that, somewhere, there’s a perfect balance between growth, employment and inflation that meets everyone’s needs. Key characteristics of Goldilocks economies may include:

• Low inflation. Inflation, typically measured by the CPI or PPI, is the rate of change in a currency’s purchasing power. The Fed aims to keep inflation around 2% to promote mild growth while staving off recession.
• Low unemployment and steady job growth. The ideal unemployment rate in a healthy economy varies, but the U.S. Federal Reserve aims for around 5%. At the same time, the labor market should grow steadily, without large expansions or contractions.
• Low interest rates. When interest rates sit low, borrowers and businesses can afford more debt, which may stimulate moderate economic activity.
• Steady GDP (gross domestic product) growth. GDP measures the dollar value of an economy’s total produced goods and services. Goldilocks economies are believed to have GDP growth around 2-3% annually.

Due to these factors, investors may enjoy moderate portfolio growth during Goldilocks periods. Stocks, bonds and real estate tend to appreciate steadily, leading to plenty of profits without excessive volatility.

Achieving a “just right” economy

Goldilocks economies are considered transitional periods within the larger business cycle. Modern economic theories hold that healthy capitalist economies experience repeated periods of expansion and contraction, or “boom and bust” cycles. As a result, it’s challenging to forcibly engineer the perfect economic periods.

Still, governments can facilitate certain activities that lead to stable economies, which may enter Goldilocks periods more naturally.

For example, governments can initiate spending programs that provide jobs, growth and stability, such as infrastructure projects. Short-term tax cuts can encourage spending and investment, while raising taxes allows the government to redistribute wealth and provide new growth opportunities.

Meanwhile, a government’s central bank (the Federal Reserve in the U.S.) can regulate the money supply and banking sector to facilitate a Goldilocks economy.

For instance, when inflation gets too hot, hiking interest rates can moderate lending and spending. When a recession looms near, slashing interest rates can increase these same activities.

Are we in a Goldilocks economy?

We’re living in unprecedented times. While our current state may not be exactly “ideal,” some economists believe we could be entering – or in – a Goldilocks economy.

For instance, economist James Knightley and Forbes senior contributor Jack Kelly both described August’s jobs report as a “Goldilocks report.”

And last month, Principal Global’s chief global strategist pointed to recent inflation data as a “Goldilocks state.”

Their proof is complex, but admittedly existent.

Interest rates are high, inflation is high, and yet, employment sits relatively steady. The manufacturing and service industries are holding strong while wage growth marches on.

While corporate profit growth has slowed substantially from 2021’s meteoric heights, growth does go on. Over 70% of companies reported positive earnings and EPS in Q2 of 2022, even while the tech industry flounders.

And despite ongoing supply chain issues, energy uncertainty and volatile investment markets, consumer spending remains resilient.

On the other hand, many stocks still squat in bear market territory, while GDP growth indicates we’re in a technical recession. Though corporate profits are in the black, they’re weakening and sky-high housing prices have begun to crawl back to earth. Meanwhile, both labor growth and wage hikes have shown signs of brittleness in recent reports amid increasing rate hikes.

Investing in a Goldilocks economy

Still, for investors, it might be that a Goldilocks economy includes a mild recession followed by a period of slow growth. Sure, equities sit well below their August highs (let alone their 2021 peaks), but the catastrophic crashes of spring have slowed.

But that doesn’t mean there isn’t negativity ahead.

For instance, Fed Chair Jerome Powell recently gave a dour speech in which he noted that “pain to households and businesses” may be necessary to reach the Fed’s 2% inflation target. That could mean depressed corporate growth and declining stock prices in the months ahead. (As is, his speech sparked a multi-day stock selloff, leading major stock indices to limp into September.)

But if a Goldilocks economy lies around the corner, investors may enjoy gradual growth ahead.

Rising corporate profits and strong consumer spending power could turn portfolios black. Bonds may hold their value, or even rise, in the face of declining or minimal inflation. Investors could see share price appreciation and dividends rise, while savings accounts flourish amid higher interest rates.

Of course, that depends on whether we’re in a Goldilocks economy or not. And for now, that much remains uncertain.

Too hot, too cold or just right: Where to invest in any economy

Because leading economic indicators are poised to fall while growth is poised to rise, it’s difficult for even the best economists to accurately predict what comes next. Currently, stocks remain somewhat volatile, bonds aren’t the safe haven investors wish them to be, and interest rates could very well rise again.

But that doesn’t mean investors should despair.

With Q.ai’s Artificial Intelligence at your back, we can help you prepare for economic conditions now and in the future.

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