How Did Stocks Do During Stagflation? Before the pandemic, inflation was at a comfortable 2.5 percent. Most consumers were able to keep up with the gradual increase in prices of essential items.
The stock market crash of 2020 and the subsequent economic shutdown brought productivity to a screeching halt. Consumers were out of work, supply chains were in disarray, and many items were impossible to find on store shelves.
Consumers stopped spending, and the government reacted to prevent financial disaster. Interest rates dropped to practically nothing, and the Federal Reserve bought large quantities of bonds to keep the market stable.
Aid programs delivered billions in grants and loans to states, businesses, and individuals, including cash payments and enhanced unemployment benefits to offset lost wages.
The rapid response was effective. From April 2020 to June 2020, inflation was below one percent as consumers and businesses adjusted to their pandemic lifestyles.
Most areas of the stock market recovered within a few months, and certain companies saw tremendous growth because they were able to capitalize on the increased demand for virtual learning, work, and play. Inflation began to creep up again, and by March 2021, it was back to pre-pandemic levels.
That’s when things started to go wrong.
What Caused Inflation In 2021?
Aid packages and low-interest rates were critical to averting a deep, lasting financial crisis, and they were very effective. Perhaps too effective. Inflation continued its rise beyond pre-pandemic levels because of supply and demand imbalances.
Consumers had more cash on hand than before the pandemic, thanks to stimulus funds and a general decrease in spending. They started buying goods instead of services with the money they saved.
However, snarled supply chains, a tight labor market, and production capacity limitations made many items hard to come by. Consumers who wanted high-demand/low-supply products were willing to pay more, driving prices up.
In retrospect, it would have been best for the Federal Reserve to begin tightening monetary policy in the second quarter of 2021, but no one was quite sure how world events would unfold. As it happened, vaccines brought COVID-19 under control by mid-year, and workers returned to their jobs.
Production capacity went up, making more goods available – though not quite enough to meet demand. Inflation persisted through the end of the year and continued into 2022.
What Is Causing Inflation In 2022?
By the end of 2021, the Federal Reserve had enough data to demonstrate that the inflation rate would continue to spiral out of control without intervention. The decision was made to stop buying assets and sell off a portion of the government’s portfolio.
The Fed also announced that 2022 would bring multiple interest rate increases throughout the year.
So far, there have been four:
March 17th – 0.25 percent
May 5th – 0.50 percent
June 16th – 0.75 percent
July 28th – 0.75 percent
However, despite the March, May, and June interest rate hikes, inflation continued its steady upward trend. That’s due in large part to the Russian invasion of Ukraine and the economic sanctions that followed. Suddenly, oil and natural gas supplies came under threat, and energy costs jumped up significantly.
Combined with the factors already pushing prices up for consumers, the increased fuel costs made continued inflation inevitable. Consumers started rethinking non-essential purchases, which caused a new problem.
Why Did The GDP Decrease In 2022?
By nearly every measure, 2021 was a great year economically. Yes, inflation was on its way up, but the gross domestic product (GDP) grew 5.7 percent. The US hadn’t seen growth like that since 1984.
However, it appears that businesses were a bit too optimistic about continued growth. They piled up inventory in preparation for the 2021 holiday season, but sales didn’t meet expectations.
That overstock meant a drop in business purchases for the first six months of 2022. Government spending also went down, along with imports and private investment.
If not for the increase in personal spending and exports, the GDP would have dropped by an alarming figure. With those mitigating factors, GDP was still down 1.6 percent for the first quarter and another 0.9 percent for the second quarter.
Is this a recession?
Historically, two quarters of GDP contraction has signaled a recession.
The debate in government now is around defining the many factors that are considered before an official designation occurs.
The group responsible for determining whether there is an actual recession is the National Bureau of Economic Research’s Business Cycle Dating Committee. That organization defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
Regardless of government debate, in the end, for most people, it comes down to the impact on household budgets and savings, whether or not there is an official recession.
For now, despite low unemployment rates, most people are feeling a financial pinch as food and energy prices go up and portfolios go down. It appears the economy is approaching stagflation – and that has everyone worried.
What Is Stagflation?
The combination of slow or stagnant economic growth, inflation, and a sudden increase in unemployment creates stagflation.
This term came into widespread use during the 1970s when these three elements came together at once. As inflation goes up and the GDP goes down in 2022, economists and market experts are concerned that it’s just a matter of time before stagflation strikes again.
Their anxiety is based on the fact that stagflation is an economic situation that is more difficult to manage than most.
Essentially, the Federal Reserve must walk a very fine line. The actions it would typically take to bring inflation down, e.g., increasing interest rates, can exacerbate economic growth and contribute to higher unemployment. Conversely, loosening monetary policy to stimulate the economy makes inflation practically inevitable.
The year-to-date drops in all three major US indexes demonstrates the difficulties that come with potential – or actual – stagflation. How have stocks reacted to stagflation in the past?
How Did Stocks Do During Stagflation?
It goes without saying that cash and bonds are a poor choice during periods of high inflation. Their rates of return can’t match the lost buying power, and portfolios rapidly lose real value.
That affects stocks, too, albeit indirectly, because the underlying companies face a series of challenges. It’s tough to plan ahead when purchasing power is unpredictable, which prevents them from diving into expansion projects, entering into long-term contracts, and so forth.
Top- and bottom-line results are uncertain, and it’s nearly impossible to give accurate guidance for use by prospective investors. Yes, rising prices mean revenue will go up, but so will expenses. Until the final numbers are in, it’s hard to say which will move faster.
What Stocks Do Well During Stagflation?
Periods of stagflation make the stock market less appealing, but investors shouldn’t discount securities altogether. It’s a matter of choosing companies that can weather the stagflation storm.
Specifically, defensive stocks perform consistently regardless of economic conditions. They continue to deliver returns when cyclical stocks falter.
Notable examples include periods of high inflation from 1946 to 1948, 1950 to 1951, 1969 to 1971, 1973 to 1982, and 2008.
In each case, defensive stocks went up while growth stocks went down. Conversely, when inflation was low during and after the Great Depression and the global financial crisis of 2009, growth stocks rose considerably.
Defensive stocks have a few advantages during periods of high inflation. One of the biggest is that they tend to hold inventory (retailers) or rely on complex equipment to operate (utilities).
Inflation drives the value of that inventory up, along with the replacement cost of utility infrastructure. That puts such companies in a solid financial position, which results in rising stock prices.
Best Stocks For Stagflation
Examples of stagflation-proof sectors include utilities, healthcare, consumer staples, and real estate. Smart stocks for stagflation include:
Investing in real estate during stagflation doesn’t necessarily mean buying real property. A more practical option is real estate investment trusts (REITs) and REIT exchange-traded funds (ETFs). The best REIT ETFs to buy now include:
iShares Mortgage Real Estate ETF
Pacer Benchmark Industrial Real Estate SCTR ETF
Real Estate Select Sector SPDR Fund
Vanguard Real Estate ETF
For those interested in exploring alternative asset classes, commodities are a smart choice. By definition, inflation means the price of certain commodities is going up – for example, food staples and oil.
In 2022, Brent crude oil has increased from January’s $87 per barrel to $123 per barrel in June. Wheat, soybeans, rice, coffee, and corn have also seen significant price surges.
Investors who prefer to leave the research to the experts can choose from various commodity-focused exchange-traded funds. Some of the most popular include:
Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF
Teucrium Corn Fund
Teucrium Soybean Fund
Teucrium Wheat Fund
United States Oil Fund
Stagflation: The Bottom Line
While current economic conditions can be compared to other periods in which inflation was high, economic growth slowed, or both, the underlying factors creating the situation – and contributing to possible resolution – are different.
Employers are finding it difficult to staff jobs regardless of the experience, education, and expertise required, making labor more costly.
In previous cases, stagflation was accompanied by high unemployment, so wages were down, and there were plenty of offshore sources to get inexpensive labor.
Today, China’s workforce is getting smaller, growth in its manufacturing capacity has slowed, and global shipping has been unreliable. As a result, US employers must seek out domestic labor or slow production – neither of which will help the stock market recover.
Staying ahead of inflation requires building a portfolio that can withstand economic slowdowns without seeing profits drop. That means sticking with stagflation-proof assets like utilities, healthcare, consumer staples, real estate, and certain commodities.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.