For the first time in almost 50 years, the world economy is facing the threat of so-called stagflation, a economic condition characterized by stagnant growth and high inflation.
In simple terms, this combination implies that companies fight, simultaneously, drops in revenue and rising costs, while consumers – potentially affected by rising unemployment and deteriorating economic conditions – may lose part of their income, having to pay more for goods and services.
In this context, the question arises: is it possible to protect my investments? While we cannot predict the direction of the global economy, it is important to adopt a defense strategy to minimize risks and even benefit from good opportunities – which there are – in a crisis scenario.
What is stagflation?
First, it is important to understand the concept of stagflation, which derives from the combination of the terms “stagnation” with “inflation”. It is an economic cycle in which the slowdown in growth and the rise in unemployment are accompanied by a persistent increase in prices, with strong impact on the lives of families and companies.
However, this is an unusual phenomenon – recessions and high inflation tend to occur, more often, separately – and very challenging for the authorities, as the Attempting to solve one of the problems can exacerbate the other..
The last time the global economy experienced a prolonged period of stagflation was in the early 1970s, when oil-producing countries in the Middle East cut off supplies to the United States and other Israel supporters. This supply shock caused a vertiginous rise in the cost of oil, causing widespread increases in prices and a sharp deterioration in economic conditions.
Also read: Stagflation: What is it and how can it affect your life?
Authorities point out risks
In a context of recovery from the global crisis caused by the covid-19 pandemic, the conflict between Russia and Ukraine and the energy crisis have exacerbated the risk of stagflationsetting off alarm bells around the world.
Recently, the probability of a recession in the world’s largest economy, the United States, rose to 50% for the second time since the 2008 financial crisis, as inflation tops 8% and is expected to remain above the Federal Reserve’s 2% target. at least until 2024. In Europe, consumer prices continue to rise and the energy crisis, added to the lasting effects of the pandemic, increase the likelihood of an economic contraction.
Faced with this scenario, the world authorities have warned about the risks of a return to the economic conditions that marked the 1970s. Recently, the International Monetary Fund (IMF) cut estimates for global growth this year and in 2023, not ruling out the possibility of a stagflation scenario if supply shocks prove “severe enough”.
The Bank for International Settlements (BIS) also underlined in its annual report that “the dangers of stagflation are great, with the combination of persistent disruptions from the pandemic, war in Ukraine, rising commodity prices and financial vulnerability obscuring the prospects”.
Read also: Inflation and stagflation: causes and consequences
How to create a stagflation-proof investment strategy
In a scenario of stagflation, it is essential to adopt a Defensive approach to investment portfolio management to minimize risks arising from persistent price increases and economic slowdown.
For this, it is necessary:
– to evaluate what assets and sectors are more likely to outperform during a period of stagnation of growth or recession;
– identify what type of investments are most protected the effects of rising inflation and less dependent on economic growth;
– Search for growth “bags” – regions of the world that are less dependent on exports and with strong growth in domestic consumption;
– diversify your investment portfolio to minimize the risk of loss;
– be aware that the stagflation won’t last foreverwhereby a long-term strategy increases the chances of recovery and of “surviving” different market cycles.
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What investments to consider?
Some investments are more likely to perform positively in a context of stagflation and these are the ones you should include in your portfolio if you are considering starting to invest or rebalancing your portfolio to face a crisis scenario.
Here are some assets and geographies you should consider:
Emerging markets – Assets from emerging markets should be part of the investment strategy, as they present themselves as growth “bags” in the context of a depressed global economy. At an advantage will be countries with a strong internal demand and with companies focused on the domestic marketas is the case of India, less dependent on foreign capital and with more room for maneuver in terms of monetary policy.
real estate – Real estate investments tend to have a weak correlation with stocks, being a good alternative even in a scenario of economic slowdown. At the same time, rental price growth tends to keep pace with inflation, often outpacing it.
Value actions – Value actions can be presented as good buying opportunities when bond prices are low due to stagflation. These are shares of companies that appear to trade at a low price relative to earnings, dividends and long-term growth potential. Choosing this type of stock contrasts with the strategy of investing in growth stocks, which are bonds of companies whose revenues and profits are expected to increase at a faster rate than the industry average.
defensive actions – Global equities tend to be negatively affected by the environment of weak growth and persistent price increases, with companies facing revenue shortfalls and rising costs. Nonetheless, not all sectors are affected in the same way: some stocks represent good opportunities given their defensive characteristics or positive correlation with inflation. These are bonds associated with goods and services that consumers cannot do without even in a crisis scenario. With inflation on the rise and the economy stagnant, people will still have to buy food, have electricity at home or access healthcare.
Raw material – Agricultural commodities, oil and gold may outperform stocks and bonds, presenting themselves as a good alternative in a context of stagflation. In times of turmoil in markets and in global geopolitics, gold is the safe haven asset par excellence, serving, at the same time, as a risk hedging in the face of rising inflation.
Regardless of the composition of the investment portfolio, diversifying is the golden rule. The more “spread out” investments are across asset classes, sectors and geographies, the more “spread out” the risk and therefore the greater the ability to protect against the negative effects of stagflation.
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