Stagflation is the unhappy marriage between high inflation and a stagnant economy. As prices for essentials such as energy, food and housing increase, the dollar’s buying power decreases. Unemployment rises and job vacancies remain unfilled as the demand for goods and services falls. You can use two investment strategies to profit during a stagflation. You can invest in securities and assets that keep pace with or exceed the inflation rate or you can invest in an inverse security designed to profit as the economy stagnates.
Inflation-Linked Corporate Bonds
Rising inflation makes it more expensive for businesses to borrow money. To attract investors, corporate bonds must offer an interest rate comparable to the inflation rate. Inflation-linked corporate bonds tie their interest rates to the Consumer Price Index (CPI). Corporations use their own CPI-based formula to update the interest rate monthly. For example, if the CPI reads 3.8 percent and the corporate formula multiplier is 2.6 percent, you would multiply 3.8 percent times 2.6 percent to get the monthly inflation-linked corporate bond interest rate of 9.88 percent.
Treasury Inflation-Protected Securities
Treasury Inflation-Protected Securities (TIPS) offer investors high interest rates without the risk of default. TIPS are sold by the Treasury Department and are guaranteed by the full faith and credit of the U.S. government. TIPS use the CPI as an index to adjust their principal and interest payments. If the CPI rises or falls, TIPS’ semi-annual interest payments are adjusted accordingly. When TIPS mature, you receive either your original principal amount or the adjusted principal amount back, whichever is higher. TIPS ability to adjust to CPI changes can help protect your investments during a stagflation.
Stock sectors linked to providing essential goods and services reward their investors with steady profits even during a stagflation. Companies that provide products with no substitutes, such as oil and natural gas companies, will pass their higher costs on to consumers. Mining companies that produce gold, silver and base metals such as iron ore, will continue to prosper from global demand. At the same time, food, beverage and entertainment stock sectors suffer from higher prices and reduced revenue as consumers cut back or eliminate their discretionary spending.
Inverse Exchange Traded Funds
The more the economy stumbles, the faster inverse exchange traded funds (ETFs) make money. Inverse ETFs select companies in a specific economic sector, such as finance or transportation, or target a specific industry, such as gold mining and natural gas exploration, and sell the company’s stock shares short. The inverse ETF buys the shares back after the price has fallen to make a profit. Inverse ETF shares are traded on the major exchanges and you do not need to open a margin account to trade them.
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