Some economists believe stagflation is either already here or set to hit in the months ahead as post-Covid growth stutters and inflation rises. What do investors need to know?
It is a phrase that conjures up unpleasant images of the 1970s. No, not Noddy Holder’s tartan jumpsuits but stagflation.
It hits when a country experiences slow economic growth at the same time as high inflation. Its last sustained appearance came around 50 years ago when inflation surged to double digits off the back of oil crises and soaring prices and was accompanied by a stuttering economy and lengthy dole queues.
Some economic experts fear that because of the Covid pandemic stagflation is back.
The Consumer Prices Index – a crucial inflation measure – rose by 3.1% in the 12 months to September. More is set to come with the Bank of England forecasting that inflation will hit 4% by the end of the year.
At the same time, economic growth in the UK is also looking fragile with gross domestic product having grown by 0.1% in July remaining 2.1% below pre-Covid levels.
“It is pretty obvious we are going through some sort of supply inflation,” says George Lagarias, chief economist at Mazars. “The disruption to the global supply chain seems persistent and could last longer into the end of 2022 and maybe even further. Demand-side inflation is more of a mystery because people have already bought what they need post-lockdown and are now more worried about their jobs going forward. We are still in secular stagnation – an economy where people want to save more than they want to spend.”
‘We are heading for a year of continued low growth and higher inflation’
When it comes to growth, he says it can’t be sustained if banks do not lend and businesses do not invest in their operations.
“We are heading for a year of continued low growth and higher inflation,” he says. “I see this stagflationary event continuing for 18 months. 2022 could be a year of stagflation across the globe.”
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Duncan MacInnes, co-manager of Ruffer Investment Company (LSE:RICA) is also preparing for a new economic era of more volatile periods of inflation and economic growth.
“That was just a theory pre-Covid, but you are starting to see it emerge now,” he says. “What we aren’t seeing is high unemployment and I believe post-Covid, governments will be less willing to accept that. You’ll see more examples of furlough and fuel payment type government schemes. The man on the street will not have as miserable a time as they did in the 1970s.”
‘Higher inflation is pushed up by higher commodity prices’
Dzmitry Lipski, head of funds research at interactive investor, believes that stagflation is unlikely and should not be the primary concern for investors.
“According to the OECD, the current period of high inflation is likely to continue over the next two years, but not persist as the global economy is growing stronger than expected,” Lipski says.
“Higher inflation is pushed up by higher commodity prices, supply disruptions and stronger consumer demand as economies re-open from lockdowns. The OECD projects strong global growth of 5.7% in 2021 and 4.5% in 2022 and inflation in the G20 countries is projected to peak at 4.5% towards the end of 2021 and slow to around 3.5% throughout 2022.
“Despite central banks moving closer to tapering, global monetary stimulus would remain for longer and support economic recovery.”
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“Are we going through a period of high inflation? Of course, we are and it might be quite a long transitory period,” he says.
“We may have inflation over the next 10 to 20 years resulting from factors such as higher energy costs as we move to clean power, higher food prices as we move away from mass agricultural production and more domestic manufacturing.
“I’m less worried about the output side because the drivers for growth and demand are there. If prices are going up and wages are going up, I don’t see why you get stagflation.”
How should investors respond to rising inflation?
So, given this uncertainty how should investors best prepare their portfolios?
Lagarias says the best way to approach stagflation is to reduce dependence on bonds. “Bonds are not friends of inflation especially at low yields. In real terms, we know that bonds are going to lose,” he says. “You look for income elsewhere such as syndicated loans, higher-yielding bonds or real estate.
“Some investors in their search for income may look anywhere such as new vehicles aggregating Spotify (NYSE:SPOT) song rights as income securities. With equities in times of stagflation you don’t have to slow down with the rest of the economy. You look for companies with genuine growth, which could be small-caps with less complex supply chains.”
Lipski says in periods of high inflation and low growth investors should consider inflation-linked bonds and real assets such as commodities, infrastructure, and gold.
In times of ‘just’ high inflation, he recommends Capital Gearing (LSE:CGT) trust, a member of interactive investor’s Super 60 list. The trust aims to preserve capital over any 12 months period and deliver returns more than inflation over the longer term.
“It aims to achieve its investment objectives through a long-only, multi-asset portfolio of bonds, equities and property, with small holdings in infrastructure, gold, and cash. The team also use index-linked government bonds, gold and safe-haven currencies,” Lipski says.
“We also like WisdomTree Enhanced Commodity ETF (LSE:WCOB) as a satellite holding as part of a well-diversified portfolio. It offers investors a broad and diversified commodity exposure, covering major commodity sectors such as industrial metals, precious metals, energy, and agriculture. The fund is well positioned to benefit from the current market climate and potentially deliver higher real returns. Historically, investors turn to commodities as a source for portfolio diversification and hedge against rising levels of inflation.”
Banks and insurance firms poised to benefit when interest rates rise
Henderson likes banks if interest rates are increased to temper high inflation. As a result, he has been increasing exposure to banks in the Lowland Investment Company.
“Insurance companies will also be beneficiaries of higher rates,” he says. “In terms of inflation, you look for firms with pricing power. They can push prices up because they have a service that people really want. Inflation hurts the equities which can’t do that.”
MacInnes, however, feels that the scale of debt in society is so large that raising interest rates will be very difficult for central banks to do. “It means you get negative real rates. That will slowly suffocate savers and investors,” he states.
“It forces people to go and take more risk. Your average Granny has been forced out of cash into government and then investment grade bonds into high-yield bonds. Inflation is nasty for most asset classes, and we are worried that bonds and stocks look very vulnerable at their high valuations. Your stocks and bonds could fall together at the same time,” says MacInnes.
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He also suggests inflation-linked bonds as a means of protection, as well as gold.
MacInnes adds: “We are positioned for a more stop-start economy and when it stops it will be met by a massive government financial response,” he says. “That will then push growth on a bit. Our portfolio is not dominated by the big US tech companies or consumer giants such as Unilever (LSE:ULVR) or luxury such as LVMH (EURONEXT:MC). It is all in economically sensitive stocks such as oil companies, agricultural commodity stocks, banks, and industrials. They will benefit from stimulated growth.”
MacInnes says passive investing will still be in vogue during this volatility but in his view the US tech-dominated indices may suffer.
“The US tech stocks have had their moment in the sun and won’t do well in an inflationary and economically volatile environment,” he says. “You may miss out on the ones which will do well by following the index.”
Passive or active, what is clear is that for a new generation of investors they have to think about the impact of inflation for the first time. For an older generation they need to unclog those memories of sideburns and loud clothes and remember their investment strategies of the past.
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