Every day in the News we hear Professionals & Economists talk about GDP,
Inflation, Unemployment, Ratings, Monetary policy, Fiscal policy etc.
Q: As an Investor, should you know these
concepts? If yes, How do these effect your investment's performance?
Macro economics is a broad subject. Here we will try to
understand one of the concept called “Stagflation”
Stagflation refers to a situation of weak economic growth
embedded with high unemployment and increasing Inflation. The main reason for
stagflation is sharp decrease in aggregate supply. Which means decrease in the
total supply of goods and services that the firms/companies are willing to sell at a given
price level in that economy. This results in sudden unexpected increase in prices
for those goods and services, which is often referred to as “Supply Shock”. As a result of this GDP of the economy decreases.
US Stagflation 1970-1979
What are the Solutions to this problem?
Government intervention either by Fiscal Expansion (Increasing government spending or decreasing taxes which may also results in
Budget Deficit) and Monetary Expansion (Increasing the money supply or decreasing
the Nominal Interest Rate).
The objective is to increase the economic stimulus , Increase output ,Expand demand and create more jobs .
However, these are all short run strategies.
Stagflation is a challenging situation for
Policymakers.
Policy changes to reduce Inflation tend to make unemployment
worse and policy changes to fight recession tend to make inflation worse.
If the Government does not intervene, decline is Wages and Input Prices used in Production Process will help bring back the
situation to Equilibrium where aggregate demand is equal to aggregate supply.
This is slow process and is politically risky, if the government fails to take immediate action.
How does this effect
Investors?
- This situation will discourage investment in Fixed Income instruments because of anticipation of Higher Inflation and Nominal Interest Rate.
- The situation will also discourage investment in Equities as Revenue and profit margins are thin.
Ans: Suggestion for Investors:
A good strategy is to stay invested, however well
diversified.
Some of the asset classes which will outperform during
Stagnation are,
- Real Assets. ( Real Estate)
- Commodities. ( Gold, Precious Metals, Timber ,Copper etc.)
- International Investments.(Economy which is not under the influence of Stagflation)
Investors could also consider Low P/E Stocks and Long Term
Bonds as a long term investment strategy.
However, be sure
that you have done enough research before you consider any of the above during
stagflation.
Investing involves risk of loss or under performance. As an intelligent investor you could
consult your Financial Planner/Investment Advisor before considering the above.
