How to invest during stagflation

Investing at its core involves putting your money to work to generate growth over the long term, with the gains (hopefully) beating inflation. But how can you invest during stagflation, when growth is low or non-existent, and inflation is high?

Stagflation is a dangerous combination of stagnant growth and rising inflation. In economic terms, the two are conceptual opposites: high inflation is usually associated with increased growth, due to higher demand for goods.

That makes stagflation a thorny issue for politicians and central bankers. It is also, though, a challenging time for investors trying to decide the top stocks and funds to invest in. Stock markets in general fall during times of stagflation, and that makes investing through index funds a dangerous game.

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Investors, though, need to prepare themselves for exactly this eventuality. Since 2 April, US president Donald Trump’s ‘Liberation Day’ tariff debacle has threatened to unwind almost a century of increasingly globalised trade, potentially driving up the cost of goods while stifling economic growth at the same time. There are even fears that the tariffs could cause a US recession.

“Deciding where to invest in this scenario is difficult,” says Rob Morgan, chief investment analyst at Charles Stanley. “Most businesses will face extra challenges such as higher costs, supply chain difficulties and uncertainties around the payback on any investments they make.

“However, the age-old rules still apply. Invest in good quality businesses and time tends to be on your side.”

We look at the key points you should consider to give your portfolio the best chance of success during a period of stagflation.

Investing during stagflation: take a long term approach

The first thing to bear in mind is that the stock market has, historically, been one of the best places for investors to put their money over the long term, despite having weathered various periods of stagflation.

The S&P 500 has only generated negative full-year returns in 11 of the last 50 years, a period which includes the Great Financial Crisis and the dotcom bubble.

When the markets fall suddenly – as they have recently – it is important to try to remember that economic downturns are, historically, transient.

“Seeing your investments reduce in value can be unsettling for investors, however, in times like these it’s important to remember the long-term nature of investing,” says Brian Byrnes, head of personal finance at Moneybox. “The markets have seen volatility at this scale before and have recovered.”

Of course, those closer to retirement might be worried about the impact of a market selloff on their pension. However, in theory, your pension manager will have shifted your allocation towards more defensive assets as you approach retirement, cushioning your pot against the worst impacts of the drawdown.

Can defensive assets hedge against stagflation?

Defensive assets are also worth considering as a hedge against inflation.

The theory behind defensive investing is that these investments will move in a different direction from the stock market as a whole.

If you want to stay focused on equities, this could mean allocating to defensive sectors.

“Some sectors are naturally more resilient to economic downturns,” says Morgan. “For instance, food and beverages, healthcare and utilities, owing to their greater share of essential rather than discretionary spending.”

Traditionally, bonds have also been viewed as a defensive asset that can shield portfolios against a stock market downturn. That doesn’t necessarily hold in the current environment: US bond markets crashed following the imposition of Trump’s ‘reciprocal’ tariffs, prompting him to reverse course and pause them for 90 days.

There is also an argument that, during a stagflationary period, the returns on bonds will be eroded by inflation.

Gold could be a safer bet, given that it has historically been a safe haven asset during times of economic turmoil. It pays no interest – so isn’t as impacted by inflation as bonds – but could well continue to attract investor interest as the situation develops.

“We continue to like gold as it benefits from both weaker growth and the more structural risk posed by rising debt levels,” says Johanna Kyrklund, group chief investment officer at Schroders.

“Gold is already at record highs thanks to the uncertainty injected into financial markets this year,” says Monk. “The metal tends to perform best when fear is at its highest and has a track record of holding its value when other assets are vulnerable to falls.”

Investing during stagflation: look for quality companies

If you are minded to stick to equities, and want to pick individual stocks rather than a tracker fund or an ETF that tracks a defensive sector, the general advice is to look for “quality” companies – businesses that have strong fundamentals that will be able to weather the stagflationary storm.

That typically means companies with strong balance sheets and low levels of debt.

“Avoiding weaker businesses that are less likely to withstand a significant downturn is sensible,” says Morgan. “Avoiding weaker businesses that are less likely to withstand a significant downturn is sensible.

“Certain businesses have an ‘economic moat’ around them. For instance, offering a unique proposition, dominating market share through a superior product or having established channels of distribution. In these circumstances, it is hard for newcomers to penetrate the market, so the strong are likely to get stronger.”

Seeking dividend-paying companies could be another strategy. Even if markets are falling, regular dividends boost your total returns.