Unlike traditional inflationary periods or recessions, where asset classes behave in somewhat predictable ways, stagflation creates an environment where both stocks and bonds can underperform simultaneously. Investors face the dual threat of rising prices eroding purchasing power and sluggish economic growth weighing on corporate earnings.
Understanding how stagflation affects different asset classes can help investors position their portfolios to mitigate risks. Some sectors and investment types may struggle, while others could offer protection or even benefit from stagflationary conditions.
EQUITIES: SECTORS THAT SUFFER AND SECTORS THAT PERFORM WELL
Stock markets typically struggle during stagflation. Unlike normal recessions, where central banks can stimulate growth by cutting interest rates, stagflation limits their ability to act. As a result, businesses face higher costs, weaker demand and tighter financial conditions, all of which weigh on corporate earnings and investor sentiment.
Sectors that suffer during stagflation
Consumer discretionary stocks: Companies that rely on consumer spending, such as retail, travel and luxury goods, tend to underperform in stagflationary environments. As inflation eats into household incomes and unemployment rises, discretionary spending declines. Businesses that rely on strong consumer confidence often experience falling revenues and shrinking profit margins.
Technology and growth stocks: High-growth companies, particularly in the tech sector, are often heavily reliant on low interest rates and strong economic expansion. When interest rates rise to combat inflation, the future earnings of these companies become less attractive. Additionally, input costs for hardware and chip manufacturers may increase, putting pressure on profitability.
Financials (banks and lenders): In normal inflationary environments, banks benefit from rising interest rates as they can charge more on loans. However, during stagflation, loan demand declines due to economic stagnation and default risks increase as businesses and consumers struggle to keep up with repayments.
Sectors that perform well during stagflation
Commodities and energy stocks: Companies involved in oil, gas, mining and agriculture tend to outperform during stagflation. Since stagflation is often triggered by supply-side shocks and rising input costs, firms that produce raw materials benefit from higher prices. The 1970s stagflation crisis saw energy companies and commodity producers generate strong returns while broader equity markets suffered.
Defensive stocks (consumer staples, utilities, healthcare): Companies that produce essential goods and services – such as food, beverages, household products and healthcare – are relatively insulated from economic downturns. Consumers continue to buy necessities even when their disposable income shrinks. Utility companies, which provide electricity, water and gas, also tend to perform well because demand for these services remains stable regardless of economic conditions.
Dividend-paying stocks: In uncertain markets, companies that pay consistent dividends can be attractive to investors looking for income. Defensive sectors such as telecommunications and pharmaceuticals often have stable cash flows and strong dividend yields, making them a potential hedge against stagflation.
BONDS: THE IMPACT OF RISING INFLATION AND STAGNANT GROWTH
Bonds typically struggle during stagflation, as rising inflation erodes the purchasing power of future fixed-income payments. However, the extent of the damage depends on the type of bond and its duration.
Government bonds and fixed-rate debt
Traditional fixed-income securities, such as UK gilts and US treasuries, lose value in stagflationary environments. When inflation rises, real yields (returns adjusted for inflation) decline, making existing bonds less attractive to investors. Additionally, if central banks raise interest rates to control inflation, bond prices fall because newer bonds offer higher yields.
In the 1970s, bond markets performed poorly as inflation surged. Investors who held long-duration bonds suffered significant real losses, as the value of their future coupon payments declined in purchasing power.
Inflation-protected bonds (index-linked gilts and TIPS)
One way to hedge against stagflation is to invest in inflation-linked bonds, such as uk index-linked gilts or US treasury inflation-protected securities (TIPS). These bonds adjust their principal and interest payments based on inflation rates, offering better protection against rising prices than traditional fixed-income securities.
Corporate bonds and credit risk
Corporate bonds face two key risks in stagflation: rising interest rates and increasing default risk. As businesses struggle with higher costs and weaker demand, their ability to repay debt deteriorates, particularly for companies with high leverage. Investors typically demand higher yields for corporate bonds during stagflation to compensate for increased credit risk.
High-yield bonds, also known as junk bonds, are particularly vulnerable during stagflation, as default rates tend to rise when economic conditions stagnate.
PROPERTY: STAGFLATION’S INFLUENCE ON REAL ESTATE AND REITS
Real estate has traditionally been seen as a hedge against inflation, but its performance during stagflation depends on several factors, including interest rates, rental demand and supply-side constraints.
Residential real estate
House prices can be affected by stagflation in two conflicting ways:
Inflation hedge – Physical assets like real estate tend to hold value when inflation rises, as rental income and property prices often increase over time.
Higher interest rates – If central banks raise interest rates aggressively to fight inflation, mortgage costs increase, making property less affordable. This can reduce housing demand and slow price growth.
During the 1970s, property markets experienced regional variations, with some areas benefiting from inflation while others struggled due to economic stagnation.
Commercial real estate and Reits
Commercial property markets – particularly sectors reliant on economic growth (such as office spaces, retail and hospitality) – tend to underperform during stagflation. Weaker consumer spending and declining business investment can lead to lower occupancy rates and rent reductions.
However, real estate investment trusts (REITs) that focus on essential properties, such as warehouses, healthcare facilities and residential rentals, may outperform traditional commercial real estate. Inflation-linked lease agreements can help preserve income streams in an inflationary environment.
CURRENCY AND COMMODITIES: GOLD, OIL and INFLATION-HEDGING STRATEGIES
Gold – The classic stagflation hedge: Gold has historically been one of the best-performing assets during stagflation. Since gold is not tied to any central bank or government, it tends to retain value when inflation erodes fiat currencies. During the 1970s stagflation crisis, gold prices surged, acting as a safe haven for investors.
Oil and energy commodities: Energy prices are often a major driver of stagflation. When oil prices rise, energy companies benefit and oil-related investments tend to outperform. Investors often turn to oil futures, ETFs or energy stocks to hedge against stagflationary risks.
Foreign exchange (FX) and the British pound: Currency markets can be highly volatile during stagflation. If investors lose confidence in the Bank of England’s ability to control inflation, the British pound may depreciate against other currencies. Investors may look for safe-haven currencies, such as the Swiss franc or US dollar, to preserve wealth.
POSITIONING FOR STAGFLATIONARY MARKETS
Stagflation creates a challenging investment environment where traditional asset classes may struggle simultaneously. Investors must be cautious, focusing on inflation-resistant assets, defensive sectors and alternative investments to navigate economic uncertainty.
While equities and bonds face headwinds, commodities, defensive stocks, inflation-linked bonds and alternative assets like gold offer protection. Understanding how different markets respond to stagflation allows investors to make informed portfolio adjustments and safeguard against economic and market turbulence.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.