The risk of stagflation is high because of three major market pressures: Barclays' Maneesh Deshpande
Many investors may have to turn to their parents and grandparents for advice on how to weather stagflation.
The last big bout of stagnant growth and high inflation was in the 1970s and early 1980s, a period when an oil shock led to double-digit inflation that prompted mortgage rates to soar above 20 per cent and was accompanied by high unemployment.
The scenario is new for most investors, since those who endured this difficult period are retired or ready to do so.
"It's been quite an adventure trying to go back and find data from the '70s about what really did happen back then because most of us were kids or in a lot of cases not even born yet," says Colin Cieszynski, chief market strategist at SIA Wealth Management.
Stagflation can be very challenging for investors because it tends to hurt both stock and bond markets.
But Cieszynski said there are a few things investors can do. One is take a more tactical approach to markets rather than the passive approach that has done really well for the last decade in stocks and 40 years in bonds.
"Stocks are volatile and so we need to recognize that so it may be more prudent to take a more defensive approach, to hold a certain level of cash and be prepared to be tactical to take advantage of opportunities or manage risk as needed."
Amid these conditions, growth sectors like technology tend to do poorly while outperformers are energy, materials, utilities and consumer staples.
Economic experts differ on whether the current environment constitutes stagflation even though spiking energy prices have contributed to a surge in inflation. Some point to GDP contraction last month in the U.S., while others argue GDP growth of 3.1 per cent in Canada last quarter paints a different picture.
IG Wealth Management chief investment strategist Philip Petursson said Canadian economic growth quells some of the worries of stagflation, while inflation is starting to moderate and unemployment continues to be low.
"A stagnant economy in my view is very weak economic growth which would be sub two per cent and I just don't think we see that even in the United States," he said.
Nonetheless, stagflation is the biggest fear in the market and every central banker's nightmare as inflation is expected to remain relatively high, said Greg Taylor, chief investment officer of Purpose Investments.
While central bank policy tries to tackle demand, their tool kits are less adept at addressing persistent supply issues that have created shortages in energy and semiconductors, leading to higher prices.
Taylor suggests investors look at holding more real assets that should increase in value with the higher inflation rate.
Canadians should be in a better position to weather a storm because the S&P/TSX composite index is heavily weighted to commodities like oil that are doing very well. As a whole, the TSX is down 2.3 per cent so far in 2022, compared to decreases ofbetween about nine and nearly 23 per cent for U.S. markets that are largely powered by technology.
Taylor also suggests that those looking at fixed income should focus on shorter duration assets, high yield or investment grade bonds rather than long duration government bonds.
Retail investors can also learn from large institutions, which have moved toward alternative investments in real assets and infrastructure. Taylor said small investors can turn to new alternative mutual fund products that have been added in the last few years. This includes a new category of liquid mutual funds that involve more hedging and option strategies.
Gold has done OK in a period ofstagflation. Taylor said it's almost a forgotten asset class but stagflation might be a reminder of how it can add value to a portfolio.
Whatever strategy you adopt, withdrawing from markets entirely has in the past proven to be a big error, said Allan Small, senior investment adviser at IA Private Wealth.
Doing so would prevent investors from realizing strong gains that tend to follow large declines. Missing out on the best five or 10 trading days in a year can cut annual returns by as much as half, he said.
"So I think for investors you want to rejig the portfolio, you may want to move money around into different things depending on your risk tolerance, time and life and all that, but you want to stay invested," he said.
Small said he's telling his clients that the best strategy during stagflation is to invest in companies that have pricing power to raise prices and put money in companies that have good growth.
Although options are limited, Small said investors shouldn't panic or fall into the trap of trying to time the market.
"Go with the strong names, leaders in their segments, leaders in their industry because ... those are the names that will be the first to rebound."