The looming spectre of stagflation, the process where an economy is dogged by both low growth and high inflation and unemployment, is awakening like an embalmed mummy after a deep slumber.
Although there has been a lot of press already this already, including some confident dismissals, nobody knows for sure whether the phenomenon last seen in the 1970s will creep back.
Ben Bernake, former US central bank chief during the global financial crisis, said this week that stagflation may be not far around the corner.
While the unemployment in the US and UK is low, the Bank of England governor Andrew Bailey recently warned of the risk of a recession next year, while Goldman Sachs (NYSE:GS) chairman Lloyd Blankfein said this week that the risk of the US falling into a recession is “very, very high”.
Bernanke agreed that a slowing US economy was highly likely and that even if inflation recedes from its current 40-year highs around 8.3%, it will remain elevated, while higher unemployment could be triggered by the first two factors.
The US and UK are among several countries where stagflationary pressures are the most elevated, according to UBS after scrutinising current and forward-looking growth and inflation data from 45 economies. The others are Germany, Sweden, Turkey and Russia.
Australia, Canada, China, Mexico and India are seeing the lowest stagflation pressure, the Swiss bank said.
Financial markets are also giving an opinion, UBS said, with the FTSE 250 pricing in a 10% chance in the UK, compared to a 5% chance from the S&P 500 constituents and the MSCI China index.
Standing way out ahead, the Eurostoxx 600 is pricing in 25% probability of stagflation, UBS said.
How best to invest
When inflation is high, cash and bonds are not thought to be safe spaces, as yields are often under water.
Similarly, in the early stages of recession at least, equities also can suffer badly, even more so if uncertainty lingers.
This pushes investors to more ‘defensive’ sectors, traditionally companies that are essential to people’s lives.
UBS has created a “stagflation protection list” that it shared with clients today, containing its most- and least-favoured shares.
This was worked out by taking the intersection of a top-down and a bottom-up approach.
The top-down approach was the highest and lowest sensitivity to a country’s or region’s ‘stagflation pressure index’, while the bottom-up approach screened companies’ pricing power to looking for stocks with the “steadiest margins through adverse economic conditions”.
The UK most favoured included several classic defensives, including perennial 'fags and booze' defensives British American Tobacco PLC (LSE:BATS), Imperial Brands PLC (LSE:IMB) and Diageo; utilities Centrica PLC (LSE:CNA), National Grid PLC (LSE:NG.), Severn Trent PLC (LSE:SVT) Vodafone Group PLC (LSE:VOD), and drug and healthcare companies AstraZeneca PLC (LSE:AZN), GlaxoSmithKline PLC (LSE:GSK) and Smith & Nephew PLC (LSE:SN).
Also there were consumer facing companies too, including Burberry Group PLC (LSE:BRBY) and Reckitt Benckiser Group PLC (LSE:RKT, ETR:3RB).
On the least-favoured list, were banes including Aviva PLC (LSE:AV.), ITV PLC (LSE:ITV), easyJet PLC, JD Sports Fashion PLC (LSE:JD.) and Marks & Spencer Group PLC, as well as some sector peers of those in the opposing list, like BP PLC (LSE:BP.) and Pennon Group PLC (LSE:PNN, OTC:PEGRY).
On the US list, most-favoured ranged from Abbott Laboratories (NYSE:ABT) and Chevron Corp, via Costco (NASDAQ:NA:COST) and Walmart, to eBay Inc, Microsoft Corp and Pfizer Inc (NYSE:PFE).
UBS’s least favoured stocks for stagflation contained more big names, from Walt Disney and Carnival Corp to Citigroup Inc (NYSE:C), Boeing Co (NYSE:BA) and Southwest Airlines (NYSE:LUV) Co.
“While many stagflation pressure index readings look very elevated today, they will likely not stay there,” the Swiss bank’s strategists said.
“Our economics teams believe US inflation has already peaked and Europe's will do so by Sept '22.”
But the pressures may remain elevated for some time, with the ‘half-life’ for the current US pressured estimated to last 29 months versus around a decade back in the 70s, with only around 20 months for Germany.