The € 25,000 question
The stagflation knows (almost) only losers
A guest contribution by Marco Herrmann
The ECB’s inflation target of around two per cent is not in sight. At the same time, the economy is cooling down. There is a risk of stagflation. Read here what the story reveals about such a scenario and how investors should position themselves.
Politicians, central bankers, investors and “little men” have their own concerns about the current high inflation. The reduction in the mineral oil tax and the legendary 9 euro ticket will provide temporary relief over the next three months. However, this is not a turnaround for the better.
One should not expect too much from the concerted action in which Federal Chancellor Olaf Scholz would like to discuss with employer and employee representatives on how to keep inflation under control. High inflation rates are likely to stick with us longer than we would like.
The restructuring of our energy industry that became necessary following Russia’s war against Ukraine, i.e. the replacement of low-cost Russian pipeline gas with expensive liquefied natural gas (LNG) from the world market, the simultaneous switch to sustainable energy solutions and the partial transfer or carry-over of production, or de-globalization for strategic reasons, are among the price drivers of the next ten years.
threat of stagflation
This will also lead to price increases in other areas. The Vonovia real estate group, for example, has promised the necessary rent increases which should correspond to inflation. In Germany, this was a whopping 7.9 percent (8.1 percent in the euro area). The ECB’s current inflation forecast in the monetary union for 2023 and 2024 of 3.5 and 2.1 percent respectively is more wishful thinking than reality.
There are some parallels to stagflation in the 1970s, not least due to the external shock of soaring energy costs due to supply constraints. Experts call the price increase in combination with stagnant or even shrinking economic development stagflation. At that time, central banks reacted with massive interest rate hikes (in the US up to double-digit percentages) and thus caused bond yields above the inflation rate.
Economy frozen by the interest rate shock
No wonder the global economy slid into recession at that time. However, the current situation differs from that of the 1970s in important respects. Today, the global debt of states, companies and individuals represents about 250% of economic output and therefore more than double compared to 50 years ago.
Excessive increases in interest rates could cause significant problems, even central banks know. Therefore, the returns of bonds below the inflation rate. Either way, bond investors are looking back on their worst year since the end of World War II. There had never been a price loss of around ten percent on German government bonds in the past. Security-seeking investors are disappointed.
I’m stock market there is also a feeling of insecurity. However, the fluctuations are within the normal range – not pleasant, but unfortunately this is part of the nature of the actions. Gold profits from devaluation are unlikely, and cryptocurrencies have just suffered a sharp slump. How should you invest your assets in such an environment, for example 25,000 euros?
A look back helps. In one study, researchers looked at the development of various asset classes in phases of low, medium and high inflation for the US market over the past 50 years. In a situation comparable to today – high inflation coupled with the risk of recession and a tighter monetary policy – stocks have done well and nominally generated an average of seven percent annually. This has at least ensured the preservation of capital after deducting inflation.
Precious metals gold and silver even achieved positive real returns in the single-digit mid-range. In general they are also good raw material, especially oil and gas, are fine at such stages. In most cases, however, they are also one of the triggers for price increases.
The € 25,000 question
Long-term investors should therefore continue to focus on tangible assets such as stocks and not be driven mad by fluctuations in between. However, good diversification is essential here to reduce individual risks as much as possible. Historically, cheaper value stocks, which currently include commodities and pharmaceuticals, have outperformed growth stocks such as fast-growing technology stocks at such stages.
Investors shouldn’t give up on the fast-growing tech sector entirely, however, as many continue to enjoy large cash inflows and now also have acceptable or affordable valuations. Risks in the consumer area are more likely to occur beyond daily needs. Holidays and larger purchases like cars, furniture and TVs are likely to be postponed due to low real income.
Gold remains an excellent addition to the portfolio due to its low correlation with equities. While there hasn’t been much movement in the price of the precious metal recently, there is upside potential as long as the real interest rate, i.e. the interest rate adjusted for inflation, remains clearly negative.
Investors should invest the smallest portion of their funds in bonds. In this case, either corporate bonds with a good credit rating and maturities of up to five years or slightly lower risk bonds with variable interest rates, or so-called floaters, are called into question. However, each must determine for themselves the relationship between material value and face value, that is, stocks and gold to bonds, depending on their age and risk tolerance.
Marco Herrmann has worked for well-known banks and investment firms since 1992. As CEO, he has been responsible for FIDUKA’s investment strategy since 2010.