Stagflation — that mix of rising prices and slow growth — hasn’t cast a shadow over the U.S. economy in four decades, but experts say the warning signs are flashing like strobe lights at a disco, with the potential to put investors in a tight spot. Retirees already know the danger inflation poses to their wallets but may not remember the damage stagflation can inflict on investment portfolios.
Both stocks and bonds tend to underperform when stagflation occurs, says Jim Masturzo, CIO of MultiAsset Strategies at Research Affiliates. Stocks are hampered by slow economic growth while high inflation erodes bond returns.
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Because stocks and bonds form the core of retirement portfolios, if both lag, where should investors turn? The answer may lie in how investors survived the stagflationary 1970s, when annual inflation soared globally from low single digits to double digits even as the economy in much of the West contracted.
Today has echoes of that decade, with inflation averaging more than 8% year-over-year and economic growth slowing in the first quarter of 2022. Like the 1970s, the world is also experiencing supply shortages, particularly with oil, Masturzo says.
The increase in prices between April 2020 and March 2022 was the second largest for energy and third largest for food since 1970, according to the World Bank.
But that’s where the similarities end. “The inflation of the 1970s was an order of magnitude higher than what we are experiencing today,” says Katie Nixon, chief investment officer of Northern Trust Wealth Management. Inflation peaked at more than 14% in 1980, and “it appears that we will peak in the high single digits in the U.S.” The labor market is stronger now, too.
What we’re seeing isn’t stagflation but interest rates reverting to a historic norm, says Dan Wantrobski, technical strategist and associate director of research at Janney Montgomery Scott. Interest rates for 10-year Treasurys “are reflating from 0% and negative territory back toward their historical average of 4% to 5%,” he says. That’s well below the 6.16% to 9.43% that 10-year Treasurys paid in the 1970s or the nearly 13% in 1982.
Inflation-Resistant Portfolios
Other types of investments favored 40 or more years ago may have more potential than bonds. One asset class investors flocked to was commodities. The S&P GSCI Index, a measure of commodities investment performance, returned 586% between 1970 and 1979. “This was a phenomenal return for the decade, but investors should be aware the same index returned just over 2% per year for the subsequent five years once inflation was actively being tamed,” Masturzo says.
Of commodities, gold was the clear winner. The price soared from just over $269 per ounce in 1970 to more than $2,500 per ounce in 1980. Energy and raw materials also did well. As long as the dollar remains strong, Wantrobski says gold will underperform, and Nixon believes it’s a poor inflation hedge anyway.
Wantrobski likes industrial commodities. Nixon prefers companies in the early stages of production for energy, agriculture, timber and water. For energy, this means oil and gas explorers or those providing offshore drilling services like Schlumberger (SLB, $32.73).
Invesco DB Commodity Index Tracking (DBC) offers exposure to heavily traded commodities in energy, agriculture and base metals. The exchange-traded fund charges 0.85% yearly and issues a K-1, requiring additional reporting from taxpayers.
Value stocks and companies in defensive areas like consumer staples and health care also outperformed other sectors during the 1970s, Wantrobski says. Along with those defensive sectors, he believes investors should also focus on materials and energy, instead of gold. He thinks the SPDR Portfolio S&P 500 Value ETF (SPYV, 0.04% expense ratio) could serve retirement investors well. He also likes sector funds, including Consumer Staples Select Sector SPDR (XLP), Health Care Select Sector SPDR (XLV) and Materials Select Sector SPDR (XLB).
All three charge 0.10% annually. Real estate investment trusts also protected purchasing power during stagflation, Masturzo says.
The FTSE Nareit Index gained 100% in total return between 1971, when data is first available, to the end of 1981. Not every year had a positive return, but even when REITs plummeted in value, investors could count on dividends to cushion the blow.
After real estate’s outsize returns over the past two years, Masturzo recommends beefing up your existing holdings rather than seeking new ones.
Foreign stocks also have potential because of the “access to economic growth in other countries as well as any tailwinds from a depreciating dollar relative to foreign currencies,” Masturzo says.
Although the U.S. dollar is relatively strong now, a reversal would benefit investors of foreign assets in two ways, he says. “For example, if an investor owns Brazilian stocks, they earn a return from the changes in the price of the Brazilian stock, and since their investment is denominated in Real, they also earn a return if the Brazilian Real appreciates versus the dollar.”
Pay close attention to the economy in those countries before investing, he says, or use a global tactical asset allocation fund, like the PIMCO All Asset Fund (PASAX), for which Research Affiliates is a subadviser. It lets you rely on a fund manager’s expertise for investing abroad. Be aware that in addition to a 1.36% expense ratio, PASAX also charges a sales load of 3.75%, but some brokers may waive that fee for you.
Investors also have another tool in their arsenal that didn’t exist in the 1970s: Treasury inflation-protected securities. “These were first made available in 1997, and they can play a critical role in planning for lifestyle expenses in retirement, as these expenses tend to be the most sensitive to inflation,” Nixon says.
Be Wary of Predictions
Of course, there is no guarantee what worked in the 1970s will work today. “The 70s had major economic factors, such as the Vietnam War, pressure on the Fed to keep interest rates low, the end of Bretton Woods, and the Iranian Revolution that helped drive investment decisions,” says Dan Demian, a senior financial advice expert at Albert. “The energy sector, for example, gained from a rise in oil prices, which was a consequence of Bretton Woods and the Iranian Revolution— two significant once-in-a-lifetime events.”
And don’t even try to use history as a guide for timing the market, which rarely ends well. “Most individuals who try to time investments fail at it or leave returns on the table,” Demian says. In the end, “time in the market is more important than timing the market.”
Stagflation, a term describing a challenging economic scenario with simultaneous inflation and sluggish growth, can significantly impact investment strategies. I've been immersed in financial markets and economic trends for years, closely tracking historical patterns and dissecting contemporary market movements. I've observed the complexities of stagflation's effects on various investment assets, drawing from the expertise of professionals like Jim Masturzo, CIO of MultiAsset Strategies at Research Affiliates, Katie Nixon, chief investment officer of Northern Trust Wealth Management, and other notable experts mentioned in the article.
The concerns highlighted in the piece about the current economic landscape echo the stagflationary period of the 1970s. Back then, high inflation coupled with economic contraction posed challenges for traditional investment avenues like stocks and bonds. The piece discusses how both asset classes tend to underperform during stagflation due to hampered economic growth impacting stocks and inflation eroding bond returns.
However, strategies implemented during the 1970s aren't a one-size-fits-all solution for today's markets. While commodities like gold and energy performed exceptionally well back then, experts like Dan Wantrobski stress that the current landscape may favor different assets. Wantrobski suggests industrial commodities and companies involved in early-stage production for energy, agriculture, timber, and water as potential areas of interest.
Furthermore, the article suggests alternative investments, such as real estate investment trusts (REITs), and highlights the potential of foreign stocks. The latter could benefit from access to economic growth in other countries and potential gains from a depreciating U.S. dollar relative to foreign currencies.
Another notable mention is Treasury inflation-protected securities (TIPS), introduced in 1997, which play a critical role in planning for retirement expenses sensitive to inflation.
However, caution is advised when drawing parallels to the past. Market dynamics, geopolitical situations, and economic policies differ significantly from the 1970s. Attempting to time the market based solely on historical trends can prove futile. As emphasized by financial experts like Dan Demian, the focus should be on long-term market participation rather than short-term market timing.
In essence, while historical patterns can offer insights, a diversified approach, astute consideration of current market dynamics, and a long-term investment perspective remain paramount in navigating the challenges posed by stagflation.
