Investors may soon need stagflation strategies, veteran advisors say.
Stagflation, an economic climate in which growth rates are sluggish and inflation is high, requires certain defensive stock market strategies, a Florida advisor says.
“Now is not the time for a low cost strategically diversified portfolio. This market is long in the tooth and there are many underlying factors that could cause a correction or pullback,” according to Matt Chancey, an advisor in Tampa. He and other veteran investment professionals warn stagflation can be brutal.
“I was a teenager and college student during the late 70s, early 80s stagflation. It was terrible,” adds Mike Whitty, a Chicago advisor, who is cautious.
“I’m anticipating a significant market correction so I would not go all-in on the stock market right now,” he adds.
If the disastrous stagflation stock market of generations ago returns, advisors say some investments can ease the pain.
Pain relief, they say, includes certain bonds that adjust to inflation, some hard assets and tax strategies that take advantage of collapsing stock markets. A defensive strategy includes real estate and commodities, investments and TIPs (Treasury Inflation Protected Bonds).
Treasury inflation-adjusted securities protect against inflation by adjusting the value of the underlying bond up when inflation rises and down when inflation declines, says a fund industry observer.
“This,” notes Russ Kinnel, a fund industry analyst with Morningstar, “makes Treasury Inflation-Protected Securities and TIPS funds the purest hedges against rising inflation. Other bonds and bond funds are vulnerable to some degree to rising inflation, but TIPS are impervious.”
“Stagflation,” adds another investing pro, “means we have low/slowing growth and rising rates,” according to Dennis Nolte, an advisor in Winter Park, Florida.
“This phase of the economy works well for investments tied to higher rates and higher quality balance sheets—so hard assets like real estate, commodities, energy, basic materials work well,” he adds.
Other investments that can weather stagflation, Nolte adds, “include blue chip stocks with great balance sheets (little/no debt) and pricing power—like tech work well. On the fixed income side, anything benefiting from higher rates—-TIPS and even senior bank loans are best, with shorter duration.”
Another advisor counsels a multi-step approach for potentially difficult times.
Anthony Watson, in Dearborn, Michigan, says rebalance the portfolio, convert pre-tax assets to a Roth IRA and look for ways to sell losing investments. Reduce taxes by tax loss harvesting, he adds.
“Selling an asset in a taxable account to lock in a loss and then buying a substitute asset to replace the original asset’s intended exposure can help you to offset taxable gains later,” Watson says. He argues rebalancing can be done through selling bonds that went up and using the proceeds, through a Roth IRA, to buy stocks that are suddenly a bargain when the stock market turns bearish.
The point of these strategies, advisors say, is at least two-fold: Some bonds and other investments such as commodities and real estate can adjust to inflation. And these investments can be effective in a stagflation environment, they say, because they don’t correlate to the stock market so they aren’t hurt when it tanks.
Tanking is what the stock market did in the stagflation of the 1970s. That’s when simultaneous high inflation and low growth rates—something many economists who believed in the Phillips Curve (See sidebar. “What is the Phillips Curve?”) had previously said would not happen—made life miserable for investors and consumers alike.
Stocks were so bad that, in 1979, “Business Week” magazine had a famous cover story that predicted “The Death of Equities (Stocks).”
The inflationary cycle was roughly between 1965 and 1983. The 1970s was the center of the stagflation storm. A slow or no growth economy combined with high inflation.
Stagflation was a problem that plagued three presidents, Carter, Ford and Nixon. They tried and failed at various schemes to solve stagflation. These included wage and price controls, whip inflation now (WIN) buttons and giving a malaise speech. But from speeches to buttons to price controls nothing worked.
Indeed, in the 1970s, annual inflation was 7.4 percent but the annual real rate of return of the S&P 500 was minus (-1.4), according to SimpleStockInvestor.com. In the succeeding decades, things improved.
By the 1980s, inflation was starting to come under control and earnings recovered. Inflation dropped to 5.1. percent and real returns were 11.6 percent. And by the 1990s, inflation was down to 2.9 percent annually and stock markers returns were 14.7 percent, reports SimpleStockInvestor.com.
Stocks recovered as the inflationary storm finally blew away. Morningstar’s Kinnel says the investors shouldn’t sell all stocks owing to recent inflation spikes. That’s because he argues stocks perform best of all the investment categories over the long run. Although Kinnel isn’t sure we will repeat a long-term period of high inflation, he agrees short term numbers have spiked.
Earlier this month (October), the Consumer Price Index was reported to go up 0.4 percent in September or up 5.4 percent a year from year ago levels. Annual inflation, over the past century, has averaged about three percent a year, according to the Federal Reserve.
Still, the 1970s stagflation era blew out those historic long-term averages. It was a bad time both for investors and consumers. That’s why many older Americans who lived through it are horrified by its possible return.
The 1970s and part of the 1980s were periods of sluggish growth combined with double digit inflation. Interest rates peaked in the low 20s. That killed industries dependent on borrowed money, such as housing and cars.
If this economic disaster happens again, Chancey adds, relatively inexperienced professionals may misread it.
Some young advisors who never lived through it, he adds, might not understand what are most effective ways of beating this unusual economic and investment problem.
“The advisors you currently work with might not be familiar or have a business model conflict that prevents them from offering these solutions to you,” Chancey cautions.
“It’s like trying to buy a pizza at a burger place, it’s just not what they do.”
NOTES: What Is the Phillips Curve?
Prior to the stagflation disasters of the 1970s, many economists believed in the Phillips Curve. “Professor A. W. Phillips,” wrote Paul Samuelson in his Eighth Edition of “Economics,” tried “to quantify the tradeoff relationship between unemployment and price wage rises.”
The Phillips Curve measured the tradeoff between inflation caused by wage and employment increases and economic growth. If you wanted a certain amount of growth, one had to accept a certain of inflation. Economist Murray Rothbard, in his “Ten Great Economic Myths,” called the Phillips Curve “bizarre.”
Rothbard wrote that “Phillips correlated wage rate increases with unemployment, and claimed that the two move inversely: the higher the increases in wage rates, the lower the unemployment. On its face, this is a peculiar doctrine, since it flies in the face of logical, commonsense theory.”
Indeed, in the stagflation era of the 1970s something peculiar happened: Feeble growth and high inflation happened at the same time. This made problems for many workers seeking jobs because the economy was hardly growing.
Many retirees living on fixed incomes also suffered. In their case, their buying power was reduced and some retirement nest eggs were suddenly inadequate.
