Worried about stagflation? Strategists say these stocks typically outperform

Published Mon, Oct 25 202111:30 PM EDT

Sam Meredith @in/samuelmeredith @smeredith19

Below-trend growth and above-trend inflation have sparked some concern about the prospect of stagflation . While the return to such an environment is broadly seen as unlikely, strategists at investment banks have identified the stocks that have outperformed in the past. Stagflation refers to an economy that is simultaneously experiencing stagnant economic activity and rising inflation. The phenomenon was first recognized in the 1970s when an oil shock prompted an extended period of higher prices but sharply falling GDP growth. In the decades since, rising inflation during a period of weak economic growth has become more normal. Yet, as energy prices and supply chain shortages soar amid the coronavirus pandemic, fears of a return to stagflation are now making the rounds. A Bank of America Global Research survey, published Oct. 19, found that 34% of global investors expect stagflation-like conditions over the coming year. That's up from 20% when compared to last month and the highest reading in almost 10 years. "We've had questions from fund managers and investors in general on that topic and whether that is a potential risk," Joachim Klement, an investment strategist at Liberum, told CNBC via telephone. He added that while fears of stagflation continue to grip the markets, "nobody really thinks this is a base case scenario." In Klement's view, there is a less than 5% chance that elevated inflation will combine with a period of close to zero economic growth next year. Investment strategists at the BlackRock Investment Institute go even further, saying they remain pro-risk since there is "no risk" of stagflation. "It's the first time since the 1970s that a supply shock is the main culprit," analysts led by BlackRock's Jean Boivin said in a research note published Monday. "This is where the comparison ends." This view has not stopped investment banks from seeking to understand which stocks are most likely to outperform if a stagflation environment did come to pass, however. Stock picks U.K. investment bank Liberum said defensive sectors and companies with pricing power were those likely to perform best during periods of stagflation. For example, food and tobacco firms, pharma and utilities. Businesses that are vertically integrated were also thought to be well-positioned. Cyclical sectors, such as construction and hardware, were likely to suffer, analysts at Liberum said. To be sure, cyclical stocks tend to move with the momentum of the larger economy. Here are Liberum's and New York-based investment bank Jefferies' stagflation stock picks: Senior : British jet and auto parts supplier Senior was identified as one defense-orientated stock that Liberum found to be a top performer during previous periods of stagflation, with Klement noting he was "pretty confident" the stock would outperform once again if such market conditions were to return. Cranswick : Liberum also singled out Cranswick, a U.K.-based supplier of food products, as a "highly specialized and niche" company that possesses the kind of pricing power likely to help it excel during a period of stagflation. "It should be able to pass on higher inflation rates to consumers, so that's the pricing power argument," Klement said. TT Electronics : British electronic components maker TT Electronics was recognized by Liberum as one of the U.K.'s top performers during previous periods of stagflation. Alongside Cranswick, Klement suggested the pricing power of TT Electronics would support the company through an environment of high inflation and low growth. IAG : British Airways owner-IAG was another of the top performers according to Liberum, which assessed the companies that tended to perform well over the last 30 years. Analysts at the investment bank have a buy rating on the stock, citing optimism over an expected relaxation of travel restrictions in the next year or so. TSMC : Analysts at Jefferies studied five stagflation-like periods since 2001 and noted so-called "cash machines," referring to firms with high-quality cash flow, outperformed strongly. The chip heavyweight, headquartered in Taiwan, was singled out as one of the top performers during previous stagflation-like conditions. Samsung : South Korean semiconductor giant Samsung was highlighted as a stagflation stock pick by analysts at Jefferies, particularly as cash flow and balance sheets come into focus. It is another example of one of the "cash machines" to have previously outperformed. BHP Group : The world's largest miner was among one of the highest market cap stock picks by Jefferies. The selection criteria were determined by companies with a market cap over $5 billion, among the top performers with high-quality cash flow, a high free cash flow track record and a solid balance sheet. China Telecom : The China-based telecommunications business scored highly across all selection criteria by Jefferies, and was a rare example of a company recognized as both a cash machine and a stock with consistently higher free cash flow growth than earnings growth when compared to other stocks in Asia and Japan.

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