The Dreaded “S” Word

By now you may have heard of the possibility of the dreaded “S” word taking over the markets and economies. Yes, that word is “stagflation”. It is a portmanteau of two words “stagnant” and “inflation”.

What is stagflation? Putting it simplistically, it is a situation where we have high inflation, high unemployment and a slow or stagnant economic growth. As you can see, it is a very difficult cycle to escape from once it rears its ugly head: high inflation leads to workers demanding higher wages, but with slow demand, companies find it difficult to do just that without hurting the bottom line. Worse still, companies may lay off workers so that they could keep themselves afloat, let alone giving in to raising pay. 

 

The most famous (and only) real life case of stagflation occurred during the 1970s in the United States, where a combination of factors such as high inflation and unemployment, coupled with the oil embargo by OPEC (Organization of the Petroleum Exporting Countries) that caused oil prices to skyrocket, created a period of stagflation that lasted until around the early 1980s. 

 

The threat of stagflation is not without justification: we are seeing high inflation rates now, coupled with hiking of interest rates which, according to basic market and economic principles, tames inflation but also brings about slow growth. Also, exacerbating the whole thing is the ongoing commodities shock and the global supply crunch. This is like history repeating itself, as what some analysts and economists commented, but others stated that policy makers and central banks would know what to do based on what they had learnt from history. There are also other arguments that the stagflation causes back in the 1970s were slightly different from the present variables that we are seeing.

 

Impact On Investment Portfolio

 

Stagflation is a combination of inflation and recession, and on the asset class level equities, bonds and cash would be negatively affected, with REITs maybe on the borderline (depending on the net result between inflation and recession). The preferable asset class is commodities, which thrive in inflationary environments as a hedge and recessionary environments as a safe haven. To really bulletproof further a portfolio during stagflation, we would need to look deeper within asset classes, like regions/countries and sectors/industries. 

 

Locations not heavily affected by stagflationary factors would be a good go-to place; China is an example where inflation and interest rates are still within economic growth level, coupled with the ability to get cheaper oil. Same goes for sectoral/industrial wise; goods and services which are still needed by the masses, e.g., consumer staples and utilities, can be considered.

 

Now comes the golden question: Will stagflation happen? My answer in seven words: Your guess is as good as mine. Regardless, one’s investment portfolio would be hit by stagflation. Diversification across and within asset classes is still the best defence in such times.

 

Stay calm, stay safe, stay invested.