Stagflation is a hot topic for investors across the globe, including in Australia where inflation hit a two decade high in March by surpassing 5 per cent.
According to State Street Global, April witnessed a surge in the stagflation topic across investor research, news and company filings, particularly as persistently high inflation forced central banks to tighten, increasing the likelihood of slower economic growth.
“Stagflation warrants attention as most investors are not old enough to have experienced it and historically it has proven a difficult economic environment and it is likely to test investment styles that favour low inflation and moderate growth,” said Bruce Apted, State Street Global Advisors’ head of portfolio management.
Mr Apted pointed to the yield curve for evidence.
“The yield curve embodies the market’s expectations for both the future course of monetary policy (the 2-year yield) as well as expectation for future growth (the 10-year yield).
“In the last 12 months, the yield curve has moved from 150 to zero which tells us the markets now expects slower economic growth ahead,” he explained.
Last week, the International Monetary Fund (IMF) said it believes inflation could become “de-anchored” from expectations and urged central banks to act aggressively.
Declaring inflation as the “the most important challenge of our time”, IMF director of Monetary and Capital Markets Department Tobias Adrian said “central banks have to act aggressively in order to bring inflation back down”.
“There is a risk of the anchoring of medium-term inflation expectations. So at the moment, we see that shorter-term inflation expectations are very elevated. But then there’s a gradual expectation of inflation coming back to target in most countries around the world.
“However, there’s a risk that eventually, inflation expectations cook the anchor and there could be more of an expectation of inflation, even in the medium term. Central banks have to counteract that by tightening monetary policy, slowing economic activity to bring inflation down,” he explained.
Similarly, AMP’s Shane Oliver told InvestorDaily that the RBA would need to act quickly to control inflation.
“A return to 1970s style stagflation with double digit inflation, periodic recessions and high unemployment is unlikely,” Dr Oliver said.
“But the RBA will need to act quickly to make sure that inflation expectations don’t rise rapidly and lock in high inflation as occurred from the late 1960s”.
In an environment conducive to slower economic growth, Mr Apted said investors may look to diversify their concentrated holdings towards sectors and styles that have historically outperformed in a more difficult economic environment.
For him and the team at State Street, the top three sectors for a falling yield curve include health care, utilities and technology. On the other end of the scale, he said, are communication services, banks and financials.
“Thematically, we have found that quality, low volatility, momentum and growth have all historically outperformed in a falling yield curve environment.”
Earlier this month, Fidelity International’s Andrew McCaffery warned that stagflation risks are intensifying as trade and financial shocks from the Russia-Ukraine war, and associated sanctions, exacerbate global inflation pressures.
Fidelity’s global CIO predicted that the concurrent hit to growth and to overall confidence is likely to be meaningful, but noted that its magnitude and duration are still uncertain.
