Stagnation occurs when the economic growth stops, the broad market for various asset classes flatlines, and the fiscal stimulus has been used up already. Various factors can cause stagnation, but recent history points to an aging population as being especially important. Japan’s example, which has been not returned to an upward GDP trend for almost 30 years now, doesn’t bode well for economies of the eurozone and other developed countries with similar demographics. However, an investor from such a country is not constrained to stagnate economies. How should the strategy for such a scenario be built?
When one economy is stagnating, this doesn’t mean that all of them are. A broker with access to international markets comes in handy. Look for ETFs or companies who are exposed primarily to countries with robust demographic growth (think China, India, Brazil, Mexico) or emerging markets in general.
Fama and French, Nobel prize winning economists, investigated a methodology called factor investing. Two such factors were growth and value. While in a stagnating economy there can hardly be any growth left, but there will always be under and overvalued companies – this is the value factor. Even though the broad market index is flatlining, there will be relative moves within the index, with undervalued companies gaining the market cap (as investors realize their fair value), and overvalued companies losing it. There are some factor-based ETFs if you don’t want to pick the stocks yourself.
A long-term sideways market almost certainly comprises many trends, positive and negative, cancelling each other out. If one looks closely, a portfolio with a long position in positive trends and a short one in the negative ones can be crafted, benefiting from both and ignoring the general stagnation. An example of a broad trend-within-a-trend would be population moves. The overall population might be shrinking in a stagnating economy, but it could likely be the case that the share of city dwellers rises at the expense of countryside. This opens the opportunity to invest in city real estate, construction companies, their corporate debt and of course ETFs based on any of these – anything that provides long exposure to this trend.
Just a bit smarter
Anything is trickier, investment-wise, than a robust bull market such as the one we have been enjoying for the last ten years. Should we encounter stagnation next, devising investment strategies based on a little bit more clever ideas such as ones provided above, will become crucial for achieving positive returns. Wide market access, experience in stock/sector selection and up to date research will differentiate good investors from the average, but in stagnation, contrary to the bull market, an average investor by definition does not achieve a positive return. That is why stagnation could be the time for careful and well thought out active investment.