3 investing strategies for navigating stagflation risks, according to analysts

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  • Energy prices have risen, raising fears of inflation.
  • Stagflation presents a problem for economic policymakers because measures to curb inflation could further increase unemployment.
  • Analysts offer some strategies that investors can take to navigate stagflation risks.

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Inflation fears have rattled investors in recent months, as prices began to rise in an economy that has yet to pick up pace. But investors can employ certain strategies to trade around these risks, analysts say.

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An economy going through a recession is one that simultaneously experiences stagnant activity and rapid inflation. This phenomenon was first recognized in the 1970s when an oil shock led to an extended period of high prices but a rapid decline in GDP growth.

Similarly, energy prices have risen recently, raising fears of inflation.

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In an October report, Morgan Stanley said the risks of a stagflation recession are attracting investors’ attention, and may stem from a “supply shock.”

“Disruptions in global supply chains have caused shortages in sectors such as energy and semiconductors. These conditions could drag on into the next year, which will keep inflationary pressures high in the short term,” wrote analysts at Morgan Stanley.

Stagflation presents a problem for economic policymakers because measures to contain inflation – such as wage and price controls or contractionary monetary policy – ​​can further increase unemployment.

Goldman Sachs also warned in October that stagflation could be bad for stocks.

Below are some approaches that analysts suggest investors can take to navigate stagflation risks.

1. A ‘Barbell’ Strategy

Morgan Stanley said investors can adopt the barbell strategy and own cheap valuation stocks with high free cash flow and dividends. Free cash flow is a measure of profitability, which represents the amount of cash a company generates after accounting for outflows to support expenses.

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Earlier this year, the investment bank said that a barbell strategy could hedge against market volatility. This strategy involves placing excess weight on two different groups of stocks to hedge against uncertainty about the market’s next move. In trying to strike a balance between risk and reward, the barbell approach goes for the two extremes of high-risk and no-risk investments.

2. Go for ‘Price Setters’ and Avoid Growth Stocks

One approach would be to invest in companies in upstream production, according to Rob Mumford, emerging markets investment manager at Gam Investments.

“The key is to be in pricing, where you don’t really want to be downstream,” he said.

Upstream refers to the input materials needed to produce the goods, while downstream operations are closer to the customers, where the products are made and delivered.

An example of upstream production would be a semiconductor firm, Mumford told CNBC’s “Squawk Box Asia” on Tuesday. A global shortage affecting everything from cars to consumer electronics has driven chip prices up this year.

As for what investors should avoid, Mumford urged caution on growth stocks.

“I think growth stocks will be weak, especially if inflation starts to move higher than expected,” he said.

Growth stocks are stocks that are expected to grow at a rate well above the market average.

3. Stick to value and cyclical stocks for now

Morgan Stanley said value and cyclical stocks benefit the most when inflation expectations rise. Value stocks are those that appear to be trading below what analysts think. Cyclical stocks follow economic cycles, rising and falling with macroeconomic conditions.

“If the risk of stagflation remains persistent, a ‘reverse trade’ strategy may emerge in terms of profitability,” the investment bank said. “It will be necessary to buy the laggards of the worst price from last month and expect a price reversal next month.”

— CNBC’s Jesse Pound

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