Are we heading for stagflation?

President Donald Trump's tariffs on imported goods have sparked concerns about stagflation. Tariffs are technically paid by foreign companies but tend to effectively be paid by importers in the form of higher prices. These higher prices then tend to get passed on to consumers. This inflationary pressure, particularly if coupled with a slowdown in economic activity, can result in reduced consumer spending and business investment. Consequently, the economy may experience declining levels of growth  while prices continue to rise, creating a challenging economic environment sometimes referred to as ‘stagflation’.

The last time the world suffered a major economic crisis with an extended period of stagflation was in the 1970s, when inflation rocketed to double figures and joblessness soared. So, is history about to repeat itself?

These environments are often driven by a major supply-side shock. For instance, the stagflation we experienced in the 1970s was driven by the price of oil quadrupling. While Trump’s tariffs similarly could represent a shock to the supply side of the economy, the price increases are not likely to match those seen in the 1970s, particularly given that oil intensity (i.e., the amount of oil consumed per unit of economic output) was higher. Moreover, unemployment rates remain close to record lows around the world—in sharp contrast to the mass unemployment seen in the 1970s. As such, a deeply stagflationary scenario is not our base case. Nonetheless, there is certainly a chance of such an outcome, and we should be prepared for it.

Historical analysis allows us to identify which assets perform best in environments of falling growth and rising inflation. The effects of inflation permeate various aspects of the economy and daily life, yet not all asset classes are adversely impacted. Equities, for instance, generally outperform bonds when growth is strong, regardless of inflation. However, when growth is below trend, performance is more varied.

Gold, real estate investment trusts (REITs) and infrastructure tend to perform better in higher inflation environments, along with Treasury inflation-protected securities (TIPS) and index-linked gilts. Conversely, nominal fixed income, particularly including credit, tends to underperform in inflationary conditions. Our diversified portfolios already hold these assets, but in a scenario where we think lower growth and higher inflation is becoming more likely, it may be appropriate to increase or decrease exposure to these assets accordingly. Meanwhile, the equity portion of portfolios may benefit from increased investment in defensive sectors like utilities, consumer staples and healthcare, while reducing exposure to highly volatile sectors such as information technology.

Of course, making such adjustments to portfolios is not always suitable for every type of investor in every circumstance, which is why it’s important to speak to your investment manager or financial planner. There also isn’t a guarantee that investments will perform as the analysis predicts. There is always risk, the chance of volatility, and the possibility that you get back less than what you invested.

Stagflation could be avoidable, but it’s always best to be prepared, even if it is just to check if your portfolio still matches your needs or if it needs to be positioned more defensively. Book an appointment to speak to an Evelyn Partners expert to explore your options.