Stagflation is probably the worst kind of “flation” that we can possibly encounter. We can cope with inflation. We know how to deal with it. We just need to raise interest rates. It can be painful, but it works.
We can manage deflation. We kind of know how to push up prices, if and when we need to. We just need to make money more available. We even know how to deal with disinflation. That is when the rate of price increases starts to slow.
But stagflation is a different kettle of fish. In theory it shouldn’t even happen.
But then we never imagined just how destructive Trump’s executive actions would have on not only the US but the impact that he would have on the global economy. He has, single-handedly, created both a supply-chain shock through the Trump tariffs and an oil shock through his clumsy attack on Iran.
Stagflation is an economic paradox. It is a combination of stagnant economic growth and high inflation. Normally, recessions are accompanied by low inflation. Meanwhile, strong economic growth can lead to high inflation.
But to experience both slowing growth and higher prices is an anomaly. It has only happened on a handful of occasions. What’s more, it is unlikely that central banks can do anything to remedy stagflation. Anything that they might try to do could just make matters even worse.
Problem is that stagflation is the result of poor policy decisions. Consequently, only a reversal of those policies can alleviate the situation. Trump would need to admit that he was wrong about the tariffs. He would also need to admit that he was wrong to wage war against Iran.
Neither of those is going to happen. So, businesses will need to make the best that they can with the cards that they have been dealt. Not all will be able to cope with dropping sales and rising prices.
Those that can, could have strong pricing power. These are businesses that can raise prices without losing market share to competitors. Generally, these companies should have demonstrated a strong track record of rising revenues whilst maintaining or increasing gross margins.
In times of stagflation, cash generation will be key. Companies that can produce cash and can continue to pay dividends could be some of the best to weather the abnormal economic conditions.
It will still be tough. But invstors holding a strong portfolio of shares that can deliver a reliable stream of cash should feel more comfortable in what could be a very uncomfortable world.
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