Stocks Plunge as Stagflation Fears Resurface

The U.S. stock market has been on a rollercoaster ride, and the latest drop has investors on edge. The S&P 500 fell sharply to end the week, with fears of stagflation once again taking center stage. Stagflation, a rare economic condition characterized by slow economic growth and high inflation, is a nightmare scenario for investors. The last time the U.S. faced stagflation was in the 1970s, and the memory of that period still haunts many market participants.



The current economic indicators paint a troubling picture. Inflation, while easing from its 2022 peaks, remains stubbornly above the Federal Reserve’s 2% target. Meanwhile, consumer sentiment has dropped sharply, and key labor market indicators are beginning to weaken. The University of Michigan Consumer Sentiment Index fell 11% last month, dropping to its lowest level since 2022. This decline in consumer sentiment is a key indicator of future spending behavior, and when confidence declines, households often scale back discretionary purchases, which can slow overall economic activity.

The new tariff policies, set to be unveiled on April 2, 2025, could exacerbate the risks of stagflation. These tariffs, including a 25% levy on steel and aluminum imports, are expected to raise costs for American businesses. Higher input costs will likely drive higher prices, contributing to inflation. This increase in prices, coupled with the slowing economic growth, creates a classic stagflation scenario where economic activity is hindered while prices rise.



Investors are already pricing in higher inflation expectations. The two-year breakeven inflation rates have risen to 3.27%, indicating that investors are concerned about the potential for higher prices. Additionally, the University of Michigan Consumer Sentiment Index shows a sharp rise in inflation expectations, with the one-year outlook climbing to 4.9%—the highest since November 2022—and the five-year outlook jumping to 3.9%. This uncertainty can lead to a decrease in consumer spending, further slowing economic growth.

So, what should investors do in response to these potential impacts? Given the potential for higher inflation, investors might want to increase their allocation to inflation-protected securities. Additionally, investors could consider sectors that are less sensitive to tariffs and have pricing power, such as technology or healthcare, which might be better positioned to pass on higher costs to consumers.

Furthermore, investors should stay nimble and be prepared to adjust their portfolios as new information becomes available. As the article suggests, "It’s a time to take the controls. It’s important to be deliberate in taking portfolio risk, in our view." This means being selective in fixed income investments, preferring short-term maturities in developed market government bonds, and considering income within private markets.

In conclusion, the current economic indicators suggest a potential for stagflation, similar to the 1970s. Investors should consider diversifying their portfolios to include inflation-protected securities and sectors that are less sensitive to economic cycles to mitigate the risks associated with stagflation. The new tariff policies could exacerbate stagflation risks by increasing input costs and creating uncertainty, leading to higher prices and slower economic growth. Investors should adjust their portfolios by increasing allocations to inflation-protected securities, considering sectors with pricing power, and staying nimble to adapt to new information.

Ask Aime: What should investors do to protect themselves from the potential impacts of stagflation on their portfolios?