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, chief investment officer of multi-asset 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 the low single digits to double digits even as the economy in much of the West contracted.
Today versus the 1970s
Today has echoes of the 1970s, with high inflation and slowing economic growth. Consumer prices year-over-year climbed every month in the first quarter of 2024, with sticky inflation struggling to fall back to the Fed's 2% target rate. Meanwhile, gross domestic product (GDP) slowed to 1.6% in the first quarter of 2024, down from 3.4% in the fourth quarter of 2023. It may sound like stagflation, but experts disagree.
"I will pull a partial page out of Fed Chair Powell's book and say I don't see the 'stag' at this point," says Katie Nixon, chief investment officer of Northern Trust Wealth Management. "We continue to see economic growth well supported by robust labor income."
Where some challenges do lie is in the "flation" side of the equation, she says. Inflation has proved harder to tame than many hoped.
"Much of the stickiness actually pertains to the surprising strength of the consumption-led economy, with services inflation leading the way," Nixon says. "Much of the service inflation is driven by wages" from a still-tight labor market.
High unemployment is the third pillar of textbook stagflation, alongside stagnating economic growth and high inflation. The U.S. economy may be experiencing high inflation and slowing economic growth, but unemployment remains well below the historic average of 5.7%, which the 70s and 80s were above.
What we're seeing isn't stagflation but interest rates reverting to a historic norm, says Dan Wantrobski, associate director of research at Janney Montgomery Scott. Interest rates for 10-year Treasuries "are reflating from 0% and negative territory back toward their historical average of 4% to 5%," he says. Current yields are still well below the 6.16% to 9.43% that 10-year Treasuries paid in the 1970s or the nearly 13% in 1982.
"We do not believe the U.S. is in danger of stagflation at the moment," he says. "If a recession does approach within the next 12 months, then yes, an economic downturn with inflation at current levels would imply modest stagflation but not anywhere near what was experienced in the 1970s period."
Inflation-resistant portfolios
If there is one lesson to be taken from the last few years, it's the importance of inflation protection. "Even in lower inflation regimes, investors need inflation hedges," Nixon says. For this, she recommends two options: Treasury Inflation Protected Securities (TIPS) and upstream natural resource equities.
"The benefits of natural resources are really twofold: You get inflation protection, but you also have exposure to the global growth outlook, which has improved in 2024," she says.
Other types of investments favored 40 or more years ago may also have more potential than bonds. One asset class that 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.
"Precious metals should continue to do well in this cycle," Wantrobski says. "We are looking for new highs in gold, silver and platinum, having already experienced such in copper prices."
Value stocks and companies in defensive areas like consumer staples and healthcare also outperformed other sectors during the 1970s, Wantrobski says. Along with those defensive sectors, he believes investors should 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 the Consumer Staples Select Sector SPDR ETF (XLP), the Health Care Select Sector SPDR ETF (XLV) and the Materials Select Sector SPDR ETF (XLB), which all have an annual expense ratio of 0.09%.
Real estate investment trusts (REITs) 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.
International 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 1.325% adjusted expense ratio, PASAX also charges a sales load of 3.75%, but some brokers may waive that fee for you.
Other foreign funds that he says could fit this bill include the Schwab Fundamental Emerging Markets Large Company Index ETF (FNDE) and the Invesco FTSE RAFI Emerging Markets ETF (PXH). These both charge more reasonable expense ratios at 0.39% and 0.49%, respectively, and no sales loads.
Be wary of predictions
Of course, there is no guarantee that what worked in the 1970s will work today. Multiple major economic factors were at play then, including the Vietnam War, the end of the Bretton Woods monetary system and the Iranian Revolution. The latter two, for example, played a key role in the rise in oil prices at the time.
And don't even try to use history as a guide for timing the market, which rarely ends well. A better strategy is to focus on time in the market rather than timing the market. Just like in the 1970s, today's challenges, too, shall pass.
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