. How Stagnation & Stagflation Impact Financial Markets

How Stagnation & Stagflation Impact Financial Markets

How Stagnation & Stagflation Impact Financial Markets

25 Aug 2022

What is Stagnation?

An extended period of slow or no economic development is known as stagnation. Real economic stagnation is defined as yearly real GDP growth of less than 2% and is characterized by prolonged periods of high unemployment and forced part-time work. Stagnation can happen at the macroeconomic level or on a lesser scale in certain businesses or industries. Stagnation can be a result of a long-term structural situation of the economy or a transient condition like a growth recession or transient economic shock.

How does the market react during stagnation? 

A sluggish economy is similar to a stagnant market. It is a market that neither expands nor contracts. Instead, it essentially stays the same. The firms that compete in the market stay the same, and their market valuations do not change.

Because the prices of the assets that investors purchase remain unchanged, a stagnant market might make it challenging for them to profit. Few gains are seen on the stock market, and during periods of stagnation, prices for stocks, mutual funds, and ETFs frequently remain stable or even decline somewhat.

Specific product markets may also experience stagnation, which prevents businesses operating there from experiencing the growth they formerly experienced. This pattern usually develops when markets get more established and there are fewer innovations available. For instance, coffee consumption decreased by 3.2% between 1960 and 1975. Small increases and declines were seen in certain years, but the total shift was minimal.

Competition may increase if markets for particular items become stagnant. Businesses may thrive in booming industries without taking customers from rivals. The only way to expand while markets are flat is to steal clients from other businesses.

What is Stagflation?

What is Stagnation?
What is Stagflation?

An economic cycle known as stagflation is characterized by weak growth, a high unemployment rate, and inflation. This confluence is particularly challenging for economic officials to manage since trying to address one of the issues might make another worse.

Stagflation, which economists formerly believed to be impossible, has frequently happened in the industrialized world since the oil crises of the 1970s.

How does the market react during stagflation?

Investors turn to reliable assets that can serve as a buffer against economic troubles during stagflation. Consequently, during stagflation, the number of equities and assets might skyrocket. Others, though, are probably going to say no.

  • Defensive Investments will Boom:

Investors are likely to favor defensive investments that will safeguard their wealth if stagflation does materialize. A rise in the price of gold is an excellent example of a commodity that may experience stagflation. In times of economic crisis, the asset is viewed as being more valuable than cash and provides investors with a high rate of return.

Comparing defensive assets to other investment classes, they often carry less risk. As a result, people look to them as a sort of safety net during economic crises. Government bonds are among the other protective investments.

  • Diversification in Investor’s Portfolios:

Diversifying their investment portfolios is a popular strategy used by investors to safeguard their money from stagflation. They could then start to diversify their investments and invest more of their funds in lower-risk ones. Investors could start buying and selling stock as a result of market volatility.

  • Delay in Large Buying:

Large purchases are likely to be delayed as consumers tighten their belts. A bit of delay in purchasing a new house may be problematic for the housing market. Over the past couple of years, house prices have climbed significantly, but if individuals cannot afford to buy, this increase is likely to slow down.