by Denise Chisholm, Director of Quantitative Market Strategy, Fidelity Investments
The current inflation backdrop looks contradictory on the surface - and that’s exactly why it’s unlikely to persist. What feels uncomfortable is, in many ways, the constraint. We’ve argued that while individual prices may continue to rise - whether driven by tariffs, energy, or other shocks - the conditions for a broad, sustained reacceleration in inflation simply aren’t in place. That’s because this cycle has already delivered something highly unusual: real income growth has been negative without a recession - not once, but twice in the past five years. Historically, that kind of hit to purchasing power tends to show up alongside rising unemployment, not during periods of full employment. And that distinction matters. When wages lag inflation, it effectively caps demand - limiting how far and how persistently price pressures can build. That’s a very different setup from the 1970s, where inflation was able to feed on itself through wages and expectations.
None of that makes the current experience feel any easier. It helps explain why sentiment has remained so weak despite an economy that continues to expand on paper. But it does change the implication for where we go next. Starting from one of the weakest backdrops for purchasing power on record, inflation becomes increasingly unlikely to accelerate - historically, it does so only about 15% of the time. Inflation, at its core, is still too much money chasing too few goods. And if incomes aren’t keeping up - if the money isn’t there - it becomes a lot harder for that chase to continue. It’s cold comfort, but it suggests the pressure may prove less durable than it seems.
That same dynamic carries through to markets in a way that feels counterintuitive. Periods of negative real income growth - bad news for consumers - have historically been strong starting points for equities, with roughly an 85% probability of gains. The relationship is odd: the deeper the hit to real incomes, the better the forward odds have tended to be for markets. More strikingly, those odds haven’t deteriorated when markets have already moved higher heading into the contraction (our current situation); and somewhat shockingly, they have improved. In other words, markets have not mapped cleanly to the economic experience investors expect them to reflect.
Part of the explanation may lie in the divergence between profits and incomes. While that gap feels extreme today – with profits holding up far better than real incomes - it isn’t without precedent. And it’s precisely these types of environments that tend to support continued job growth and extend the cycle. If the post-2020 period has been a recovery, it hasn’t been an easy one. But it is increasingly looking like a durable one. And for equity investors, that distinction matters: broad-based booms often mark the late stages, while slower, uneven expansions - frustrating as they are - tend to lengthen the runway for both the cycle and the secular bull market.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
