Stagflation is coming, but not in the way many investors think. The 50 years since stagflation last hit means there are a lot of misconceptions about how stagflation of the 70s affected stocks…it’s kind of like how you remember high school like this…when it was actually a lot more like this.
In this video, I’ll explain stagflation; what it is and what causes it. I’ll show you why we could be heading towards the worst stagflation in decades and how it will affect the stock market. I’ll then reveal three investments to buy and two to avoid in the coming stagflation disaster!
Nation, prices in America more than tripled in the 16 years to 1982. You see here the consumer price index, a measure of prices in the U.S. from 1966 to 1982…tripling over the period. That’s annual inflation of 7.2%! Put another way, imagine if your monthly rent jumped from $1,140…that’s the average in the U.S. to almost $3,500 in that time. Or imagine the $15,000 savings you’ve got stashed away for emergencies, imagine that now only buys $5,000 worth of the things you need.
Not only was the 1970s one of the worst decades for investors but it destroyed anyone saving money. The combination of high price increases and low economic growth set the economy back decades and all signs are pointing to the potential for it to happen again.
Misconceptions on Stagflation and How to Save Your Investments
I’m going to start with a quick definition because there are a lot of misconceptions about when stagflation happened last and how it affects the stock market. I’ve included a clickable index in the video description but please watch through the video because you need to know the warning signs as well as just the stocks to buy. Nation, the best time to put on your life vest is before the ship is sinking…and what I’m about to show you will help you find that life vest when stocks hit a stagflation-sized iceberg!
I’ll share three stocks to watch for stagflation later in this post but if you want to see five stocks I’m buying no matter what, check out the free report in the video description above. These are the five biggest stocks in my portfolio and I’ll show you what they are so look for that link below.
Before how stagflation affects stocks though, we need to explain what stagflation really is and what it means for you.
What is Stagflation and What Does It Do?
And the definition here is surprisingly simple. Stagflation is just a combination of stagnation and inflation. It’s when you have higher inflation and lower economic growth. That’s it. It doesn’t have to be double-digit inflation or even a recession. You just need an inflation rate that is above the rate of economic growth to completely destroy people’s savings and their investments.
And the thing about inflation is that it’s so much a function of what people expect, that once you start down that path…you’re totally screwed. Just the expectation of higher prices means people demand higher wages and companies start raising their prices to get ahead of it…and that keeps the inflationary cycle going.
Think about this. The last run of stagflation started in the late ‘60s. It was 1966 that inflation really started taking off after a decade of bad policy decisions, and price increases didn’t start cooling off until 1982…17 years later. Prices increased an average of 7% a year over the period while the economy grew just 2.2% annually.
Think about the things you’re planning over the next 17 years and how they’d be affected by prices becoming three-times more expensive? Planning for your kid’s college tuition…sorry Timmy, ain’t gonna happen. Planning on retiring in the next 17 years…think again!
What Causes Stagflation and Why are We on an Unavoidable Path to Higher Prices?
The most misunderstood thing about stagflation is that most people think it’s just caused by too much government spending that boosts inflation. Now this is a factor but if we really boil it down, it really breaks down into a crisis of confidence in the U.S. dollar.
This is why we see runaway inflation during and after wars. Not only does government spending increase and deficits get out of hand but people just generally lose confidence in the value of the dollar. If we look at the consumer price index since 1947, you can almost dot the biggest price increases with the major wars. You had WWII ending ending in ’45 and then Korea in the early 50s. Spending and the crisis around Vietnam set up inflation of the late 60s into the 70s and inflation spiked again in the early 90s with the first Gulf War.
Between Vietnam, Watergate and eventually taking the dollar off the gold standard in 1971, the public’s faith in the greenback was smashed and investors rushed to real assets that could hold their value against a worthless currency.
Inflation touched nearly 15% before coming under control in the 80s and if you think it can’t happen again…all the signs are there.
I want you to look at this chart of the M2, which is the amount of money in the system, here from 2017 to this July. And this shows the percentage increase each year, so how much the government printed and pushed into the economy. Before last year, it was fairly consistent around 5% a year…the amount of money in the system grew by about five-percent a year.
And then we dialed it up to as fast as the printing presses would go. Over the year to January, the government increased the money supply by 25%…more than five years of printing in a single year!
Now that massive stimulus of money creation likely kept us out of a depression but the bill comes due…it always comes due.
We’re already seeing it in home prices which have jumped more than 16% in the last year, the fastest growth since the very peak of the housing bubble. In fact, it’s an increase in home inflation we’ve only seen about four times in the past 60 years.
We’ve already seen consumer prices jump to their highest level in decades. Prices increased by more than 5% over the last year, an increase we’ve only seen twice since the era of stagflation.
And now the Fed and economists want to say, don’t worry…inflation is just going to be temporary…nothing to worry about, but the danger is that it’s anything but short-term. In fact, we might not have seen the worst. If you compare the increase in rents over the last year with home prices, rents have only increased about 2% on average against that 16% surge in home values. That’s because the eviction moratoriums have kept landlords from raising rents for fear of not getting anything and not being able to evict tenants.
What happens though as the eviction moratoriums come off though and rents catch up with home prices? That owner’s equivalent rent, that accounts for more than a third of the entire consumer price index, and is about to surge higher as rent increases take effect. Add to this wage increases that are just starting to show through on a tight labor market and we’re going to see high inflation well into next year.
Inflation is heading higher and it’s not going to be short-term…the only thing we’re missing then is slower economic growth for full-on stagflation.
And that as well is on the way. The U.S. economy could be about to hit a brick wall and economists at Goldman Sachs believe we could see growth as slow as 1.5% by the second half of next year.
Former Italian Prime Minister Monti believes stagflation is the #1 threat to the European economy and is likely to hit globally. Niall Fergusson is predicting a 60s style setup where the Fed lost control of inflation and started that 17-year cycle.
We don’t have a war to contend with but just came off 20-years of wartime spending along with the war against the pandemic, and we’re seeing a historic crisis of confidence in the U.S. dollar. The dollar’s share of international reserves fell to a 25-year low last year. Nobody wants to own a currency that is being massively devalued by stimulus spending!
How Stagflation Affects the Stock Market and Personal Finances
I’ll show you how stagflation affects the stock market next but just as important, how does it affect your personal finances and jobs?
Everyone wants to talk about stagflation and stocks…and yes, it is an investing channel but the affect here on the rest of your finances can be just as brutal.
Your job could be the first to go as stagflation builds with higher unemployment because of slowing economic growth. Companies aren’t able to pass on all their higher costs to consumers so lower profits mean less hiring. Unemployment jumped to 6% early in the 70s and stayed there for most of the decade, hitting 9% in ’75 and peaking at 11% in 1983.
After stagflation makes you unemployed, it then destroys your savings with rising prices. So when you thought that $30,000 in an emergency fund was going to be enough…now it only buys ten thousand worth of stuff it bought before. That’s one of the biggest hits from stagflation, anyone living on a fixed income like seniors or with cash saved away…cash is trash and savers are destroyed.
And the problem here, the reason that earlier bout of stagflation lasted 17 years, is because the Fed is powerless to fix the economy. The central bank can’t just lower interest rates or pump more money into the economy to juice growth because inflation is already too high. The Fed runs by two rules, maximum employment and stable prices. Even if unemployment is high, it can’t let inflation get even further out of control so it pretty much just has to sit there and watch all this happen.
Best and Worst Investments to Look Out For Before Stagflation Happens
So what are the best and worst investments you can buy before stagflation hits?
One of the biggest surprises to how stagflation has affected investments is that it’s not the bond destruction people usually think. You see, the conventional wisdom is that inflation just destroys the value of bonds. Since bonds pay a fixed payment and interest rate, as inflation increases then that payment is worth less. The result is that as inflation and interest rates increase, the value of bonds falls.
And all that is true but the return on a bond portfolio actually beat stocks over the worst stagflation years from 1966 through ’82 and they beat inflation as well. A portfolio of corporate bonds returned 7.4% versus inflation of 7.2% over the period.
And the reason is that bonds mature, they pay back the investment regularly, so you’re able to reinvest that money at the new, higher interest rates. This means, heading into stagflation, you want to focus on shorter-term and intermediate term bonds so you’re getting that money back faster and can reinvest just as inflation is picking up.
A good example of this would be the Vanguard Short-Term Bond Fund, ticker BSV, with its 1.5% dividend yield. The fund holds thousands of bonds in U.S. Treasuries or investment-grade bonds, really the safest fund out there.
What’s more important though is the fund has an average duration of 2.8 years. That means the average bond held matures in less than three years and the fund will be able to reinvest that money constantly, collecting the higher yields.
Stocks are really where we see the biggest problem with stagflation. The Dow index hit 1000 in January of 1966 and didn’t break that level again until 1982. It was only through the dividend yield that investors came out ahead and produced a 6.8% annualized return.
Now that poor performance in stocks versus bonds might not work out the same over the next few years but it’s important to understand that stocks aren’t the cure-all most investors think when planning for stagflation.
Stocks that do better will be those in the consumer staples sector, so think companies selling products you need to buy every day or week. Companies selling packaged foods can better pass along that inflation and higher costs because people always need to buy food. Stocks that tend to do worse against inflation are those without the pricing power and those dependent on a strong economy, so think growth stocks and technology companies. These company’s get the double whammy because a slowing economy isn’t helping to grow sales like investors expected AND they aren’t able to increase the price of their products because of competition.
Of course, gold was the standout investment in the 70s. Gold only began freely trading in 1971 at $35 an ounce when Nixon took the U.S. off the gold standard and it surged to over $800 by 1980…for a 41% annual return. Less than 10 years invested in gold would have made you 24-times your money!
Now, some are saying gold is already expensive so we might not see the same kind of returns over the next few years even if inflation heats up. In fact, if you look at the return on gold over the last 50 years, it’s produced an 8.2% annual return and 9.4% over the last two decades, so I’d agree that it’s probably overvalued at this point unless we get extremely high inflation.
Finding the best investments during stagflation is really about dissecting what inflation really is, and that’s by definition when the dollar isn’t worth as much as it was. So understanding that, you just need to look at the assets that hold their value, what’s called real assets. These include things like commodities, so gold, but also real estate and even cryptocurrencies. If the dollar is going to be worth less, then you should be putting your money in hard assets or digital currencies that are going to preserve that value.
Best Stocks to Buy to Avoid Stagflation
So we know the higher-level assets, now what are the best stocks to buy and ones to avoid for stagflation?
Here, besides making sure you have investments in real estate and cryptocurrencies, I would focus on dividend stocks. These are a strong bet against stagflation because the constant cash flow can be spent or reinvested at higher rates. Most dividend stocks, like the three I’ll highlight here, also tend to be companies in stable, mature industries.
One of my favorite dividend stocks period is Arbor Realty Trust, ticker ABR, with its 7% dividend yield.
It’s also well positioned against stagflation though as a direct lender to multi-family, senior housing and other commercial real estate properties. Arbor has grown the dividend by 16% annually over the last five years and real estate will be one of the best sectors if we hit that inflation cycle.
Shares of Gold Fields Limited, ticker GFI, are down this year but only after a solid run over the last few years and pay a 3.8% dividend.
Gold Fields is a large, diversified miner with an all-in sustaining cost of just $1,079 per ounce which means it’s already making a sizeable profit and could see that increase if inflation takes gold prices higher.
Our third stock to buy for stagflation is one of the largest MLPs, Energy Transfer, ticker ET, with its 6.3% dividend yield.
Energy Transfer is possibly the best MLP in the industry with a very strong balance sheet and diversified revenues across storage, transportation and terminals. Higher inflation could easily send oil prices over $100 a barrel and the last time that happened, shares of ET were trading at over $30 each.
On the other hand, there will be a lot of stocks that could be crushed during stagflation. These will be the tech and growth stocks that will get hit not only from a slowdown in the economy but also as they struggle to pass on those higher costs to customers.
Here I’m thinking stocks like Shopify which could see sales fall as consumers shift to the necessities as well as a seller market that will have a hard time passing on higher costs. Other tech stocks like Garmin could also suffer on a valuation that is pricing in years of sales growth that probably won’t materialize if the economy slows.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.