How to prepare your portfolio for stagflation

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  • Inflation has risen dramatically recently, and if growth is stagnant, the economy is struggling.
  • The consensus view on Wall Street is that concerns about “stagflation” are overblown.
  • Experts explain how to prepare your portfolio for the nightmarish stagflation scenario.

It’s not just your imagination: everyone is talking about stagflation.

Research interest in the term has exploded to 13-year highs over the past week, according to data from Google Trends, as everyone from professors to portfolio managers engages in heated debate on the future of the economy as inflation rises.

For the uninitiated, stagflation is a rack for “stagnant” growth and runaway “inflation”. It is the worst of both worlds for investors, who would much prefer robust economic growth and stable but low inflation.

Stagflation was a phenomenon of the 1970s that puzzled economists of the day, and it took interest rate hikes that crippled growth to stop it. A lot of today’s market watchers weren’t alive then, but everyone’s fingers crossed that history doesn’t repeat itself.

There are two main reasons behind today’s stagflation concerns. First, the latest Consumer Price Index (CPI) report showed inflation remained searing in September as prices rose 5.4% year-on-year. And second, supply chain shortages have been exacerbated, with the demand for goods far exceeding the supply of workers and natural resources.

However, the severity of the threat is open to debate.

Six experts from academia, finance and wealth management shared their take on stagflation with Insider. Most agreed that the term is an imperfect description of the current economic climate, but all expressed caution about price pressures. Steve Chiavarone, portfolio manager at Federated Hermes, told Insider in a recent interview that investors who don’t care about inflation at all are “crazy.”

“Stagflation requires a very specific set of circumstances which are generally rare and occur over a very specific set of times,” Chiavarone said. “However, if I told you that the risk of stagflation right now is 0%, I would be lying.”

The business of the bull: don’t sweat stagflation

The current consensus on Wall Street is that inflation is worth watching, but it is unlikely to derail the stock rally. This is the view of Goldman Sachs, which calls for a slowdown in price spikes, as well as of BlackRock, whose head of investment strategy in the Americas has called stagflation fears “misplaced” in the world. a recent note.

This sentiment is shared by Keith Lerner, co-CIO and chief market strategist at Truist Bank, who said in a recent interview with Insider that the rhetoric about stagflation is “overblown” and little more than the latest headwind in a “carousel of worries” which perpetuates looms over the markets.

What proponents of stagflation miss, or outright ignore, is that economic growth is not stalling, Lerner said. This derails the first stage of the stagflation thesis. Strong growth with high inflation should only be called “inflation” – and there is a simple explanation for inflation today, according to Lerner.

“If you want to have the best economic growth in 40 years, you’re also going to have one of the highest levels of inflation over decades, on your own,” Lerner said. “Part of the inflation is due to the fact that we have a lot of demand and a limited supply – in large part because of Covid – because the demand has grown so quickly and the supply is so limited.”

Truist’s view is that GDP growth will reach 6% this year and be between 4% and 4.5% in 2022, Lerner said, adding that these growth rates would be roughly double those of ‘before the pandemic. Naturally, inflation will “stay more stable” at around 2.4% next year, Lerner said.

Supply constraints are lasting longer than expected as pent-up demand remains firm and the shift in spending from goods to services continues, Lerner said. But he added that there were “glimmers of hope” in reports of companies solving supply chain problems by restocking.

The bear case: take stagflation seriously and take shelter

Most mainstream economists, including those in the

Federal Reserve
, see inflation through rose-colored glasses and are about to wake up abruptly when it doesn’t just go away, says Fergus Hodgson, director of economic research firm Econ Americas.

“We already have inflation that should sound the alarm bells, and the Fed is powerless to stop it,” Hodgson wrote in a message to Insider. “So we only need constant low or negative growth to match the description.”

Skeptical of the Fed at heart, Hodgson believes that the US central bank’s dual mandate of ensuring stable prices while maximizing employment is too difficult and too big a task. He should not be “the arbiter of the economy”, adding that the government buys bonds to provide emergency relief

liquidity
to the economy during the pandemic was a “big mistake,” Hodgson said.

Inflation is “problematic” at current levels, but could stay there for the next five years or more while GDP growth falls flat, Hodgson said. He thinks the United States is in big trouble because the Fed cannot slow inflation without raising interest rates, which would cripple growth. Moreover, Hodgson added, the country’s debt load is “too big to handle” and cannot meet the interest payments it would have to pay if rates soared.

Despite his concerns, Hodgson doesn’t believe the sky is falling. The US economy is strong and “extremely resilient,” said the director of Econ Americas, but he believes inflation will last longer than expected and weigh heavily on growth, although the situation will not “explode” .

“We are going to have to take a real toll in the United States, a real tightening of the belt and accept that Americans have been living beyond their means for a long time, especially the federal government, and they are paying the price at the moment”, a Hodgson said. “I don’t see an easy solution. I wish I had.”

How to invest – with or without stagflation

Given the clear divergence among experts on stagflation, investors would be well advised to prepare for either situation.

After all, it’s possible that neither the “transient inflation” camp nor their “1970s repeat” counterparts are entirely right, says Andy Kapyrin, research director at RegentAtlantic Capital.

Inflation is already showing up in wages and rents and will likely persist for the next two years, Kapyrin wrote in a message to Insider. But he added that there was no need for investors to panic about a long-term slowdown thanks to long-term trends like globalization and an aging population in countries like the United States and the United States. China which should contain growth and inflation.

If inflation and growth are on the rise, focus on cyclical stocks exposed to commodities, wrote Frank Greywitt, co-senior portfolio manager at DWS Group, which manages $ 1.1 trillion in assets, in a message to Insider. Specifically, energy infrastructure stocks would be attractive, wrote Greywitt, who is also co-head of DWS Group’s infrastructure titles.

Conversely, a stagflation scenario calls for caution and an emphasis on high quality stocks who can constantly increase cash flow and possess the pricing power to force customers to eat higher input costs, Greywitt wrote, highlighting the utilities sector and communication towers.

This thinking is supported by Ryan Johnson, director of portfolio management and research for Buckingham Advisors, an Ohio-based registered investment advisor. Johnson highlighted stocks of companies with pricing power as winning in an environment of high inflation in a message to Insider, adding that these quality companies are generally innovators in their fields.

Outside of the stock market, investors should avoid long-term, low-yielding bonds and instead opt for real assets that can generate positive cash flow for years, Johnson wrote. He added that exposure to commodities may be wise, but only as a trade – not a long-term catch.

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