The stock market could take a big hit from the brewing pressure of stagflation — the combination of economic stagnation and inflation — and investors could combat it by hiding out in companies with higher pricing power, according to Goldman Sachs. Stagflation is a rare period of low growth and rising prices that was first recognized in the 1970s. The unique phenomenon has come back on investors' radars, as many fear the burst in post-pandemic activity could start to slow, while inflation may accelerate to high levels with ultra-easy monetary policy still in place. Goldman said that during the stagflationary periods over the past 60 years, falling profit margins and rising interest rates reduced the median quarterly S & P 500 real total return to minus 2.1% from a 2.5% median gain for all quarters. That is worse than the average returns in environments characterized solely by weak economic growth or high inflation, Goldman said. To be sure, the firm reiterated that stagflation is not the firm's base case, but acknowledged it should be on clients' radars. Inflation has been at 3.6% year over year in the past couple of months, the highest since the early 1990s, according to the Federal Reserve's preferred gauge the core personal consumption expenditures price index. "If inflation remains high alongside a weakening economic growth outlook, firms with strong pricing power should be best positioned to maintain profit margins despite slowing revenue growth and rising input costs," Goldman head of U.S. equity strategy David Kostin said in a note. For stocks with high pricing power, the Wall Street firm screened Russell 1000 stocks with high and stable gross margins relative to sector peers. Meanwhile, their gross margins have not declined recently. Goldman said the basket of stocks exhibiting high-pricing power outperformed a low-pricing power basket by 15 percentage points from June to August, but lagged by 11 percentage points in the past few weeks. These high-pricing power stocks include consumer names Tapestry , PVH , Under Armour and Colgate-Palmotive . Some tech names also made the list, including Adobe , Oracle , Synopsys and Workday . Goldman just slashed its U.S. economic growth outlook , citing the expiration of fiscal support from Congress and a slower-than-expected recovery in consumer spending. The firm lowered its 2022 GDP annual growth forecast to 4% from 4.4%, and took down its 2021 number to 5.6% from 5.7%. The firm believes inflation will peak in coming months, however, which will reassure investors and help lift the S & P 500 to 4,700 by the end of 2021. The year-end target represents a 7% gain from Friday's close of 4,391.34. — with reporting from CNBC's Michael Bloom.
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The stock market could take a big hit from the brewing pressure of stagflation — the combination of economic stagnation and inflation — and investors could combat it by hiding out in companies with higher pricing power, according to Goldman Sachs.