Are You Ready For Stagflation?

| October 17, 2011 | 0 Comments

Stagflation… the very word strikes fear into the hearts of anyone who lived through the 1970s.  It conjures up images of low economic growth, surging inflation, sky high energy prices, and of course, crippling unemployment.

Although I was just a young boy in the 1970s, I remember the effects of stagflation well.

Unemployment hit my home town, which relied on the auto industry for most of its jobs, like a ton of bricks.  Long lines at the gas station were a regular thing.  And all the adults were constantly complaining about inflation, high interest rates, and horrible stock market returns.

But what exactly is stagflation?

The term describes a specific set of economic conditions.  On one hand, economic growth slows down dramatically… in a word, the economy stagnates.  On the other hand, inflation and unemployment both skyrocket, and each remains at high levels for some time.

Here’s the problem…

If the government pursues an economic policy designed to lower inflation, it could inadvertently hurt economic growth.  And if the government implements policy crafted to boost growth, it could drive inflation even higher.

It’s a horrible dilemma for policy makers.

But stagflation’s impact is felt most heavily by ordinary citizens.

In the 1970s, real GDP growth plunged from 4.4% to an annual average rate of just 3.3%.  Meanwhile, inflation surged from 5.5% to an annual average of 7.4%, with a peak of 13.3% in 1979.  That’s never a good combination.

Slow economic growth also led to another problem… unemployment, which jumped as high as 9% in 1975.

No question about it, the stagflation of the 1970s left many people out of work and drove the prices of most goods and services into the stratosphere.  It was a difficult time for many to say the least.

The scary thing is one legendary investor thinks we’re heading straight toward another nasty bout of stagflation…

On Friday, Jim Rogers said the US is likely to experience a period of stagflation worse than the 1970s.

Right now, the inflation rate stands at 3.8% and unemployment is 9.1%. But Rogers thinks the Fed’s money printing marathon over the past few years will send inflation soaring even higher this time around.

And Rogers’ opinion is not one to be taken lightly…

In 1973, he co-founded the Quantum Fund with another legendary investor, George Soros.  Over the next ten years, the fund gained a whopping 4,200%.  That compares to just a 47% return for the S&P 500 over the same period.

Clearly, Rogers knew how to profit in a stagflationary economy.

And in the late 1990s, Rogers gained fame once again with a bold prediction.  At a time when technology stocks were all the rage, Rogers was saying it was time to get into commodities.  Most people thought he was crazy to recommend anything other than stocks.

But as it turns out, Rogers was spot on…

As stocks plunged in the early part of the new millennium, commodities entered a multi-year bull market.  All kinds of commodities soared in price as China went on a global commodity buying binge.

Rogers’ history of success is what makes his stagflation prediction so scary.

If Rogers is right, we’re in for much higher inflation this time around.  While in the 1970s only the US Fed was printing money, today we have many central banks around the world running their printing presses non-stop.  With so much monetary stimulus going on globally, the combined effect should eventually drive global inflation through the roof.

The big question then is how to prepare your investment portfolio for a potentially crippling round of stagflation?

The simple answer is to add investments that will do well in a stagflation impacted economy.  Investments that perform well in periods of stagflation are your hard assets… things like real estate, commodities, and precious metals.

From 1973 to 1981, the Goldman Sachs commodity index posted an average annual return of 12.1%.  That’s 6.2 percentage points better than stocks and 7.3 percentage points higher than the Treasury bond.  But most importantly, commodities outpaced inflation by 4.7 percentage points a year.

Clearly, investors who had exposure to commodities during the 1970s did better than those focused solely on stocks and bonds.

So, how can you protect your portfolio if Rogers is right and we’re heading for a stagflation nightmare?

The simplest way is to add a broad-based commodity ETF to your account.  The one I like best is PowerShares DB Commodity Index Tracking Fund (DBC).  This ETF invests in futures contracts on 14 of the most heavily traded and important physical commodities in the world.

Through this ETF, you can gain exposure to oil, natural gas, industrial metals, precious metals, grains, and many others.  These are all key commodities whose prices would likely soar if the economy enters a phase of stagflation.

Believe me, if stocks and bonds both enter bear markets simultaneously, you’ll be glad you have a small part of your portfolio in DBC.

And DBC doesn’t just do well in stagflationary environments.

In fact, DBC has been outperforming stocks for several years now.  Over the past five years, DBC has gained 5.8% annually on average.  That’s more than double the S&P 500’s return of just 2.7% over the same time period.

Take a closer look at DBC for your portfolio.  The fund is a simple, cost effective way to gain broad exposure to the commodity markets.  And it’s a great way to hedge against the colossal damage stagflation can deal to your stocks and bonds.

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Category: Bonds

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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