Investing for stagflation: Bank of America’s Hartnett says we are in the first phase

Published Fri, Sep 10 202112:52 PM EDTUpdated Fri, Sep 10 20211:11 PM EDT

Stagflation is upon us, according to Bank of America global investment strategist Michael Hartnett. The combination of stagnation and inflation is a rare period of low growth and rising prices. Stagflation has come back on investors' radar as many fear that the burst in post-pandemic activity could start to slow, while inflation may accelerate to high levels with an ultra-easy monetary policy in place. During the 1970s, stagflation was first recognized when an oil shock and a depreciation in the dollar led to a simultaneous surge in price pressures and the unemployment rate. Looking at what Hartnett calls the three phases of stagflation in the 1970s, the widely followed strategist believes we are in stage one, and he broke down how to invest against this backdrop. First phase Hartnett argues that stagflation first appeared in 1965 without any visibility or anticipation. This phase coincided with inflation and interest rates breaking out to upside from multiyear ranges, while the stock market also reached record highs. Inflation has undoubtedly shot higher amid the economic recovery from the pandemic. The Labor Department's consumer price index rose 5.4% in July from a year earlier, matching the largest jump since August 2008. During the episode decades ago, equities outperformed via "a barbell of small cap value and Nifty 50 tech," Hartnett said. Looking at stock performance in various pockets of the market from 1965 to 1968, small-cap stocks had the biggest gains with an annualized total return of over 30%. Value and tech stocks were also winners with a more than 20% rally back then. On the other side of the spectrum, the worst-performing stocks were telecoms, which lost about 5% on an annualized basis during the phase of stagflation. Investing in government bonds and utility stocks also lost money back then. Second phase In 1971, President Richard Nixon took the U.S. off the gold standard, meaning terminating convertibility of the U.S. dollar to gold. The move caused a decline in the value of the dollar against other currencies, adding to inflationary pressures in the U.S. The sharp rise in inflation ended the Nifty Fifty bull market and kickstarted volatility and commodity bulls, Hartnett said. The Nifty Fifty refers to a group of 50 large-cap stocks on the New York Stock Exchange that were the most popular among investors in the '60s and '70s. During this phase of stagflation, small caps turned into the biggest loser after leading the market in the previous stage. Commodities were the winner of the era with a near 15% annualized gain from 1969 to 1973. Hartnett believes the next phase of stagflation will start in 2022. Third phase The third and last phase of stagflation started in 1974 and ended in 1981, Hartnett said. Because of persistent inflation, real assets outperformed nearly all asset classes back then, the strategist pointed out. Consumer and tech stocks were the biggest laggards during the period. Wharton professor Jeremy Siegel recently said owning real assets like stocks is the best defense against inflation. Tangible assets, like real estate and commodities, have also been used as inflation hedges.

A trader works on the trading floor of the New York Stock Exchange (NYSE) in Manhattan, New York City, U.S., August 17, 2021.

Andrew Kelly | Reuters

Stagflation is upon us, according to Bank of America global investment strategist Michael Hartnett.

The combination of stagnation and inflation is a rare period of low growth and rising prices.

Stagflation has come back on investors' radar as many fear that the burst in post-pandemic activity could start to slow, while inflation may accelerate to high levels with an ultra-easy monetary policy in place.

During the 1970s, stagflation was first recognized when an oil shock and a depreciation in the dollar led to a simultaneous surge in price pressures and the unemployment rate.