Current Outlook – Concerns About Stagflation

Slow growth and rising prices are the calling cards of stagflation. Thus far, in 2022, the setup for the global economy seems to be calling for higher risk of stagflation. Coming out of the Covid-19 pandemic, it seemed that while halting an economy could be done very quickly, starting an economy back up was a multi-year challenge. Overlaying Russia’s invasion of Ukraine, continuing challenges from Covid-19, and more hawkish sentiment from central banks, stagflation seems like a real possibility.

For developed economies, stagflation has not been experienced for many decades (for the US, not since the 1970s). Again, stagflation is characterized by a period of slow economic growth coupled with rising price levels. This is a concern because if prices rise too fast, consumers' purchasing power erodes and leads to less confidence. Lower confidence is a feedback loop that continues to weigh on growth as businesses halt their growth, fewer people are employed, and consumer spending erodes even further.

Stagflation is not as large a concern for developed countries like the US and Canada as opposed to developing nations. These less developed economies will experience a more significant negative impact from rising energy and food prices worldwide. However, the global economy has been slowed by supply chain issues arising from Covid-19 and continues to persist today. Furthermore, the hawkish sentiment from central banks to combat inflation will slow down demand and slow down economic growth even further.

Asset Classes That Should Outperform in a Stagflation Environment

As mentioned, a period of stagflation may not be as significant of a risk for developed nations. However, it is still possible that it may occur. Investors may want to consider ways to position their portfolios to mitigate the negative impacts of stagflation.

Asset classes that have historically outperformed in stagflation environments are:

Inflation-Protected Securities

Inflation-protected securities are fixed income instruments with increasing returns in conjunction with inflation. Therefore, if inflation is higher than expected, these securities will outperform. Also, during periods of uncertainty, government inflation-protected securities are considered to be of higher quality since there is no default risk.

Commodities or Commodity-Related Equities

When inflation is on the rise, commodity prices generally increase as well. Therefore, having exposure to these commodities can help an investor mitigate the negative impacts of stagflation. Some examples of commodities include oil, gold, silver, copper, wheat, lumber etc.

Real Estate

Real estate is a tangible asset (much like commodities) that may benefit from an increase in prices since the value of real estate may also appreciate. Furthermore, the rental income derived from real estate has the potential to increase as well.

ETFs to Consider in a Stagflation Environment

Some ETFs that Canadians may use to gain exposure to the asset classes which may outperform are as follows:

TIPS

QTIP (Mackenzie US TIPS Index ETF)

• AUM: $499M
• Mgmt. Fee: 0.15%
• Expense Ratio: 0.17%
• YTD performance: -5.9%

ZTIP.F (BMO Short Term US TIPS Index ETF)

• AUM: $272M
• Mgmt. Fee: 0.15%
• Expense Ratio: 0.17%
• YTD performance: -0.1%

Commodities

XMA (iShares S&P/TSX Capped Materials Index ETF)

• AUM: $150M
• Mgmt. Fee: 0.55%
• Expense Ratio: 0.60%
• YTD performance: +6.9%

XEG (iShares S&P/TSX Capped Energy Index ETF)

• AUM: $2,681M
• Mgmt. Fee: 0.55%
• Expense Ratio: 0.61%
• YTD performance: +75.6%

Real Estate

VRE (Vanguard FTSE Canadian Capped REIT Index ETF)

• AUM: $309M
• Mgmt. Fee: 0.35%
• Expense Ratio: 0.38%
• YTD performance: -15.4%

CGR (iShares Global Real Estate Index ETF)

• AUM: $250M
• Mgmt. Fee: 0.65%
• Expense Ratio: 0.71%
• YTD performance: -15.9%

Data for this article is as of June 9, 2022.