The shifting economy continues to throw fresh challenges at investors after two years of mammoth growth. The most challenging one though could be around the corner: stagflation.
Stagflation, a period of high inflation and slow economic growth, is a difficult and painful oxymoron to overcome. it also makes assets increasingly difficult to select.
Reading: How to invest in stagflation
Stocks are becoming less attractive after a couple of years of strong growth, as companies face high costs and slower demand, bonds run into trouble as interest rates rise, and cryptocurrencies face a long period of coolness as risk appetite falls.
Therefore, investing during stagflation requires you to be creative in managing your portfolios, as commodities, currencies, and real estate are potential avenues to beat inflation and stubbornly curb growth.
what does stagflation mean? the worst of both worlds
Stagflation is considered the worst of both worlds. High levels of inflation, which are at more than 40-year highs of 9.1% in the United States, are starting to weigh on demand.
but falling demand is unlikely to adequately cool rising prices. energy costs remain artificially high following russia’s invasion of ukraine, and demand is recovering faster than supply chains can cope as pandemic-era restrictions are lifted all over the world.
means that central bank interventions, most recently the largest single rate hike by the us federal reserve, are unlikely to happen. uu. (fed) since 1994, hold short-term price increases but are expected to reduce demand, fueling inflation risks.
In June 2022, the World Bank warned that the risk of prolonged stagflation had increased, with global growth projected to more than halve between 2021 and 2022.
It means that stocks, which have seen some years of strong growth and high price-earnings, and bonds, popular in a deflationary recession, have become less attractive to investors.
While these assets are not entirely hands-off, investing during stagflation means thinking outside the box to approach these assets differently and working to incorporate safe-haven and countercyclical assets.
Which assets perform best in stagflation?
The playbook for investing during stagflation is completely different from the one used in the prolonged bull market era of 2020 and 2021. Avoid riskier stocks like growth stocks and cryptocurrencies in favor of value and assets that perform well in a recession. .
Added pressure also comes from trying to beat inflation, which could mean investors require a return of up to 10% per year. analysts say that commodities and a select class of stocks and bonds may be the most effective in threading this needle.
goods
according to research by the world gold council, historically, the winners during periods of stagflation between 1973 and 2021 have been “defensive assets and real assets, particularly gold, while equities have been the biggest winners.” have suffered, followed by a mixed performance of fixed assets. income.”
An efficient stagflation investment strategy might consider commodities like oil and precious metals like gold as a safe haven.
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brent crude remains elevated around 14-year highs as energy insecurity mounts, while gold has broken $2,000 twice since 2020 and trades 40% above June levels of 2019.
In a research note published in April 2022, nn investments said oil prices were likely to continue rising.
“Oil prices are volatile due to geopolitical tensions, strong demand and low inventories. lockdowns in china will have a negative impact on demand; oil demand from russia and europe will also be adjusted downwards,” they said.
“Meanwhile, the probability of a new nuclear agreement with Iran and the return of Iranian production has increased. this, combined with supply growth from opec+ and elsewhere, should push the oil market into surplus in the coming months, barring drastic sanctions on russian oil exports to europe, which we consider unlikely.”
actions
Stocks continue in the midst of a broad sell-off. The S&P 500 (US-500) has lost more than 14% of its value so far this year, while the tech-focused Nasdaq 100 (US-100) has lost more than 21%. there are concerns of an earnings downturn, which could send the stock down even further.
“Stagflation episodes can be particularly brutal for equity investors, who have historically seen the worst average returns during these phases, pressured by rising costs and falling revenues,” the research team said. of the world gold council.
The agency suggested that not all stock indices endure stagflation in the same way. based on their analysis of historical data between 1973 and 2021, US staples outperformed the consumer discretionary sector during periods of stagflation, with a 7.9% quarterly business-cycle-adjusted return compared to a 1.3% decline for the latter.
credit and bonuses
While the credit market, including government bonds, sees increased risk of devaluation due to rising interest rates, some analysts see it as a better avenue for rewards in this cycle.
in a research note on overcoming stagflation shared with capital.com, barclays was more positive about returns offered by european investment credit (ig) than equities, as gross domestic product growth ( gdp) forecast by the bank for next year falls to 0.5%.
“Given the flow dynamics so far this year, it is clear that equities continue to have more consensus than credit as well. In previous recessions, equities fell 30%-35% peak to trough vs. IG credit’s 10-15%,” they added.
“since we’re down ~20% in stocks and ~13% in ig, we’re arguably two-thirds or more of the way there. On a risk-adjusted basis, any further decline in the stock could be comparable to that seen in IG, but in absolute terms, the stock has more downside risk.”
Research by Goldman Sachs weighed how investors and policymakers were viewing stagflation risks and responses in March, with inflation-linked bonds being the most attractive.
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“What we’re seeing is a regime change that we haven’t experienced in modern times, which makes it very difficult to be constructive on bonds,” said Blackrock VP Philipp Hildrebrand.
“This environment also suggests an increase in allocations to private markets. We also remain relatively bullish on government equities, but geopolitical risks could derail their returns depending on how the situation evolves.”
strategies to overcome stagflation
It is important to consider what to invest in during stagflation, but it can be just as important to consider how to invest.
short sale
While it can be difficult to look for success stories amid a sell-off in the market, investors may prefer to take the opposite route. they could take a stand against companies they believe will fare worse in a period of stagflation in an act known as short selling.
Shorting could also be part of a hedging strategy, where investors take an opposite position in the market to offset losses during a downturn.
According to data compiled by marketwatch, health and consumer discretionary stocks top the list of shortest stocks. This includes home health and hospice provider Enhabit (Ehab), and cosmetics, skincare and fragrance company Revlon (Rev), where 64% and 60% of their respective “floats “(the company’s publicly available shares) were short.
Keep in mind, however, that short selling is a risky strategy and you should always do your own due diligence before making any investment decisions. always have a risk management plan and never trade without a stop loss.
diversification
Ultimately, it is difficult to compare the current phase with previous periods of stagflation, such as that seen in the 1970s, and a diversified portfolio is the best approach for current conditions, according to a study by Barclays.
“Not only have economies become much less dependent on oil since the 1970s, but the trilogy of globalization, the internationalization of asset markets, and innovative monetary policy have all distorted the financial landscape. in turn, which makes it much more difficult, if possible, to compare the current economy with that of the past,” said barclays.
Please note that analyst predictions may be wrong. forecasts should not be used as a substitute for your own research. always do your own due diligence and remember that your decision to trade or invest should depend on your risk tolerance, market experience, portfolio size and objectives.
Please note that past performance is no guarantee of future performance. and never invest or trade money you can’t afford to lose.
final thoughts
All investments carry risk at any time. those risks increase during periods of high inflation and low economic growth, particularly when things are finely balanced between stagflation and recession.
“Stagflation wouldn’t be good for anyone, but some assets would probably be better than others. Investors could turn to real assets linked to earnings or inflation, such as property or infrastructure,” said Laith Khalaf, Chief Investment Officer at AJ Bell, in an exclusive note for Capital.com.
khalaf also noted that periods of stagflation and recession may be easier for those investors focused on long-term goals to weather, noting, “alternatively, they could just look to invest in stocks and keep a firm eye on the long-term.”
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frequently asked questions
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