Stagflation presents a unique set of challenges for investors. Unlike typical economic downturns, where falling demand is accompanied by lower inflation, stagflation is characterised by high inflation, weak economic growth and rising unemployment. This makes traditional investment strategies – such as relying on government bonds for stability or growth stocks for long-term returns – less effective.
Navigating stagflation requires a strategic approach focused on diversification, inflation-resistant assets, defensive sectors and liquidity management. Understanding which investments perform well in stagflationary conditions can help investors protect their portfolios and maintain purchasing power.
DIVERSIFICATION STRATEGIES TO PROTECT PORTFOLIOS
Diversification is essential in stagflationary environments, as different asset classes respond in varying ways to inflation and economic stagnation. A well-diversified portfolio can reduce overall risk and enhance stability by spreading exposure across assets that perform differently under stagflationary pressures.
One of the key principles of diversification during stagflation is to avoid overconcentration in assets that are negatively impacted by high inflation or slowing growth. While equities and bonds may struggle, commodities, defensive stocks and alternative assets can help balance risk.
Balancing equities, bonds and alternative investments
Investors should reassess their portfolio allocations to ensure they are not overly reliant on sectors that suffer during stagflation. Reducing exposure to high-growth equities, which are vulnerable to rising interest rates and limiting reliance on long-duration bonds, which lose value in inflationary environments, can help mitigate risk.
Allocating a portion of the portfolio to commodities, inflation-linked bonds and real assets can provide a hedge against rising prices. Additionally, dividend-paying stocks and defensive sectors can offer stability and income generation when economic growth stalls.
INFLATION-RESISTANT ASSETS: PRESERVING VALUE IN STAGFLATION
Stagflation erodes purchasing power, making it essential to invest in assets that can outpace inflation. Certain asset classes have historically provided strong returns in stagflationary periods due to their ability to retain value when prices rise.
Commodities and precious metals
Commodities, particularly oil, agricultural products and industrial metals, tend to outperform during stagflation because supply-side shocks often drive inflation higher. Investing in commodity ETFs, futures or shares in mining and energy companies can provide a natural hedge against rising costs.
Gold and other precious metals are also attractive during stagflationary periods. Gold has historically been a safe-haven asset, performing well when inflation is high and economic confidence is low. Unlike cash or bonds, gold does not lose its purchasing power during stagflation, making it a preferred store of value.
Inflation-linked bonds
Traditional bonds tend to perform poorly in stagflationary environments, as inflation erodes the real returns of fixed-income investments. However, inflation-linked bonds, such as UK index-linked gilts and US treasury inflation-protected securities (TIPS), are specifically designed to adjust for inflation, preserving purchasing power.
These bonds are particularly useful for investors seeking low-risk exposure to inflation-resistant income streams. By incorporating inflation-protected bonds into a portfolio, investors can hedge against rising prices while maintaining some fixed-income stability.
Real assets: Property and infrastructure
Real estate and infrastructure investments can provide inflation protection due to their tangible nature and ability to generate income. Properties that have rental agreements tied to inflation-adjusted leases can help investors maintain steady cash flows.
Investing in real estate investment trusts (Reits) that focus on residential, healthcare or logistics properties can provide an indirect way to gain exposure to real estate while maintaining liquidity. Infrastructure projects, such as toll roads, utilities and renewable energy assets, can also be inflation-resistant investments due to their essential nature and stable revenue streams.
DEFENSIVE SECTORS AND VALUE INVESTING APPROACHES
Equities tend to struggle during stagflation, but not all sectors are affected equally. Investors who focus on defensive stocks and value-oriented investments can find opportunities for stability and potential returns.
Defensive sectors that perform well in stagflation
Certain industries are less sensitive to economic cycles and continue to generate revenue regardless of economic conditions. These sectors tend to outperform during stagflation because their products and services remain in demand even when consumer spending declines.
Consumer staples: Companies that produce essential goods such as food, beverages, household products and personal care items tend to maintain stable earnings during economic downturns. Supermarkets and packaged goods manufacturers are prime examples of businesses that remain resilient.
Healthcare and pharmaceuticals: The healthcare sector is largely immune to economic slowdowns, as people continue to require medical treatment, prescription drugs and healthcare services. Investing in pharmaceutical companies, healthcare providers or biotech firms can provide defensive exposure.
Utilities and energy: Essential services such as electricity, water and gas maintain steady demand, making utility companies relatively stable investments. Energy companies, particularly those in oil and natural gas production, can benefit from higher commodity prices during stagflationary periods.
Value investing in stagflation
Growth stocks – particularly in the technology and discretionary sectors – tend to struggle during stagflation due to higher interest rates and weak consumer demand. Investors may shift toward value stocks, which are companies that trade at lower price-to-earnings ratios and often pay consistent dividends.
Value stocks, particularly those in industrial, consumer staples and financial services sectors, can offer greater resilience in stagflationary environments. Companies with strong balance sheets, low debt and reliable cash flows tend to outperform businesses that rely heavily on borrowing and future earnings growth.
THE ROLE OF CASH AND LIQUIDITY MANAGEMENT DURING STAGFLATION
During stagflation, liquidity management becomes critical. While cash typically loses value in high-inflation environments, having liquidity provides flexibility to take advantage of market opportunities and cushions portfolios against volatility.
Holding cash strategically
Keeping too much cash in a high-inflation environment can be detrimental, as its real value declines over time. However, maintaining a portion of a portfolio in cash can be useful for short-term stability and opportunistic investments.
Investors can mitigate cash devaluation by holding short-term, high-interest savings accounts, money market funds or inflation-linked short-term bonds that offer some protection against inflation.
Avoiding excessive leverage
Debt becomes a significant burden in stagflationary periods, as interest rates rise while economic growth stagnates. Businesses and individuals with high levels of debt may struggle with repayments, increasing the risk of defaults.
For investors, this means being cautious about highly leveraged assets or investments that are dependent on borrowing. Reducing exposure to companies with high debt loads or avoiding margin trading can help protect portfolios from excessive risk.
POSITIONING FOR STAGFLATIONARY UNCERTAINTY
Successfully navigating stagflation requires a proactive approach to risk management and an emphasis on inflation-resistant, defensive and diversified investments. Investors should focus on assets that can maintain or grow in value despite economic stagnation and high inflation.
Key strategies include:
- Diversifying portfolios to reduce reliance on assets vulnerable to stagflation.
- Allocating to inflation-resistant investments, such as commodities, inflation-linked bonds and real assets.
- Prioritising defensive sectors and value stocks that can withstand economic slowdowns.
- Maintaining liquidity to take advantage of opportunities and avoid overexposure to debt.
While stagflation presents challenges, historical lessons provide valuable guidance for investors. By adapting portfolio strategies to account for rising inflation and weaker economic growth, investors can protect wealth and position themselves for long-term stability in uncertain markets.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.