Investors have been concerned about stagflation in recent months as prices begin to climb in an economy that hasn't yet picked up speed. Analysts argue that investors might use a few ways to trade around these risks. Stagflation occurs when an economy faces both stagnating activity and rising inflation at the same time. This tendency was initially noticed in the 1970s, when an oil shock resulted in a prolonged period of rising prices yet rapidly declining GDP growth.
Similarly, energy prices have lately risen, raising inflation concerns. Stagflation risks are attracting market attention, according to Morgan Stanley, and might result from a "supply shock."
"Global supply chain disruption has resulted in shortages in areas such as energy and semiconductors." These circumstances are likely to persist until next year, keeping inflationary pressures strong in the short term," Morgan Stanley analysts noted.Stagflation is a concern for policymakers since measures to combat inflation, such as wage and price regulations or contractionary monetary policy, may lead unemployment to rise even more. In October, Goldman Sachs cautioned that stagflation might be harmful for markets.
Analysts recommend a few strategies for navigating stagflation concerns, which are listed below.
A 'barbell' approach
According to Morgan Stanley, investors can use a barbell strategy to buy firms with low valuations but substantial free cash flow and dividends. Free cash flow is a metric of profitability that represents the amount of cash a company generates after accounting for spending outflows. A barbell strategy, according to the investment bank, helps protect against market pullbacks. To hedge against uncertainty about the market's next move, this technique entails being overweight on two distinct sets of equities. The barbell technique attempts to strike a balance between risk and reward by straddling the two extremes of high risk and no-risk investing.Invest in 'price setters' rather than growth firms.
According to Rob Mumford, investment manager of developing countries equities at Gam Investments, one way would be to invest in companies involved in upstream production.
"The idea is to be in price setters," he added, adding that "you don't want to be really downstream."
Upstream activities are those that are closer to the client, where items are created and distributed, and downstream operations are those that are further away from the customer. Semiconductor companies, for example, are an example of upstream production, Mumford said on CNBC's "Squawk Box Asia" on Tuesday. Due to a global scarcity affecting everything from autos to consumer electronics, chip prices have skyrocketed this year.When it comes to what investors should avoid, Mumford advises caution when it comes to growth stocks.
"I believe growth stocks will be susceptible," he said, "especially if inflation begins to run over expectations."
Growth stocks are those that are predicted to increase at a faster rate than the market average.
- For the time being, stick to value and cyclical stocks.
When inflation expectations rise, value and cyclical equities profit the most, according to Morgan Stanley. Value stocks appear to be trading at a discount to what analysts believe they are worth. Cyclical stocks tend to rise and fall in lockstep with the economy, increasing and falling in lockstep with macroeconomic conditions.
"A'reversal trading' strategy could stand out in terms of profitability if stagflation risk continues to arise," the investment bank warned. "This would include purchasing the month's worst price laggards with the expectation of a price reversal the next month."