Navigating Stagflation In Your Portfolio

Stagflation is characterized by rising inflation and a declining economic picture. This environment brings about a unique asset mix for your portfolio.

Navigating Stagflation In Your Portfolio

While there has been lots of talk recently about a recession (characterized by 2+ quarters of GDP decline), a more troublesome economic condition may be brewing: stagflation.

Stagflation occurs when inflation runs high, but economic output stalls meaning that the economy and consumers cannot keep up with rising cost of goods.

In this environment, companies are forced to cut costs, including workforce reductions which then result in rising unemployment rates. Consumers adjust their spending habits, spending and saving less as they are forced to direct more funds to cover basic necessities like food and fuel.

While a typical asset allocation strategy during a bear market sees a flight to safety (think low volatility / blue-chip socks), stagflation bring about a unique asset mix.

Assets To Consider

In a stagflation environment, investors position themselves into areas that benefit from rising inflation, but have elements of defense to protect against economic decline.

  • Unlevered Real Assets: This includes infrastructure and real estate that are characterized by sustainable debt loads. Remember, when interest rates rise, the debt servicing costs increase and more revenue is directed to cover this expense. Look for companies that are more than able to meet their debt requirements.
Utilities ETFs
  • Commodities & Energy: With rising inflation, raw goods see their prices increase whether its commodities like copper, lithium or gold - or oil prices.
Commodities & Energy ETFs
  • Consumer Staples: Regardless of consumer habits, the staples areas service basic human needs like food/beverage manufacturers and grocers. With rising inflation, more consumers' cash is spent purchasing basic goods rather than on discretionary wants like clothing.
Consumer Staples ETFs

What's unique about the sectors above is, staples and utilities are defensive sectors but energy is riskier. In times of market uncertainty, investors typically unwind out of riskier assets (e.g., energy) and into defensive / stable sectors. However, with high inflation, raw assets like energy and base materials rise. Oil prices are also buoyed due impart to oil embargos placed on Russia as a result of their invasion of Ukraine.

Assets To Avoid

  • Fixed Income: We covered investing in fixed income during a rising inflation + interest rate environment here. The cliff notes version is, as interest rates rise bond prices move inverse - meaning they fall. While typically viewed as a safe asset during market calamity, a high inflation environment with aggressive central bank tightening makes it a difficult proposition to want to own bonds. Instead, you can look towards real return or inflation-linked bonds.  
  • Cash: With any market downturns, investors often get spooked and sell out of their positions. Either they direct those funds towards safer assets, or leave the market entirely and place it into cash. However, with inflation running hot during a stagflation environment, the cost to keep your portfolio in cash is expensive. If current inflation persists you are essentially paying 7% to hold cash in your chequing account.
  • Technology: Not all tech companies are created equal. Companies like Constellation Software which focus on M&A or other well capitalized companies that generate a profit may be relatively unscathed. However, companies which have been burning cash and growing by all means necessary over the past decade have seen, and will likely continue to see multiples compression as investors place a higher hurdle rate on these investments. Put simply, investors demand more from these companies to warrant the share price they had several months ago when sitting at all time highs.

Concluding Thoughts

This issue is not meant as a research piece into the likelihood of a recession or period of stagflation. Instead, we want to enable our readers and users with the tools to build their portfolio effectively regardless of market conditions.

If we do enter a period of stagflation, consider adjusting your portfolio allocations towards areas that benefit from increased inflation while resisting the effects of a declining economic picture.

Note: The information contained in this article is not and should not be construed as investment advice, and does not purport to be. The information and opinions provided should not be taken as specific advice on the merits of any investment decision. Investors should make their own investigation and decisions regarding the prospects of any topic covered herein.

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