As the phenomenon of rising inflation and a possible recession becomes more of a talking point, a UK-based wealth manager works out what is the best place for investors to take shelter.

The ugly term “stagflation” – melding rising inflation and recession – is back in fashion as wealth managers figure out the wisest asset allocation stance.

The number crunchers at Schroders have plotted performance of components of global equity indices since 1995, examining which sectors have fared the “best” – or least-worst at any rate – to work out what clients should do. The UK-listed firm plotted average sector returns versus the MSCI World Index of developed countries indices since 1995. It found that the best performing stocks during these periods have been “defensive” sectors such as utilities (up 16 per cent); consumer staples (14.2 per cent); and real estate (11.8 per cent). Cyclical sectors such as IT have done poorly (down by 6.7 per cent) and industrials (-3.3 per cent) and financials (-0.5 per cent) have been hurt.

One exception to the problems for cyclicals are energy stocks, which posted an 8.4 per cent result over the analysed period, because their revenues are tied to energy prices – one of the forces pushing inflation up at the moment. 

“We think a flexible approach to equity investing can take advantage of these performance differentials and potentially minimise significant losses,” Sean Markowicz, CFA, strategist, Strategic Research Group, Schroders, said in a note yesterday.

“Let’s suppose for a moment that historical returns during stagflation periods were repeated and mapped onto current regional sector weights. In this scenario, UK and European equities would be expected to outperform a global market-cap weighted portfolio by 4 per cent and 1 per cent per year, respectively,” he said. He noted that in contrast, emerging market equities would underperform by 0.6 per cent, while both the US and Japan would lag by 0.5 per cent.

“Of course, there is no guarantee this would happen and other macroeconomic factors such as the level of interest rates and the strength of the US dollar also play their part,” Markowicz said. 

“Nevertheless, tactically adjusting your regional allocation may shield your portfolio if the global economy slips into stagflation. Investors with the additional flexibility to invest across different sectors and companies – as well as regions – may be even better off,” he added.

It appears, then, that drilling down into performance characteristics of stocks during periods of potential recession/actual inflation can yield valuable insights, even though, to coin a phrase, history never repeats itself exactly, but it does rhyme.

A few days ago, UBS argued that while recession is a certainty at some point, clients should focus on shielding from inflation at the moment. (See here.)