Paul R. La Monica

Wall Street could soon face one of its worst nightmares: a so-called stagflationary environment that is tough for investors to navigate.

Monday's disappointing manufacturing-activity report from the Institute for Supply Management, and the big miss on job gains in the latest ADP private sector employment report Wednesday are signs that the U.S. economy may be losing steam. That's the stag, as in stagnant, part of the stagflation equation.

Then there's inflation. With President Donald Trump continuing to push for more tariffs on America's trading partners, there is the risk that inflation pressures will remain stubborn. That could put a dent in consumption.

"President Trump's disruptive trade policies and escalating tariff disputes are weighing on investor sentiment, both at home and abroad," said Nikos Tzabouras, an analyst with Tradu, an investing app. "Concerns over stagflation are mounting in the U.S., with weakening consumer confidence threatening to curb spending."

Stocks fell in volatile trading earlier this week as tariffs against Canada, Mexico, and China took effect Tuesday. The market rebounded a bit Wednesday afternoon after Trump delayed tariffs on automobile imports from Mexico and Canada, but the major indexes were down earlier in the day. So what should investors do now? Brace for more worries about rising prices and a slowing economy.

"A stagflation trend was already in place before tariffs," said Adam Phillips, managing director of investments with EP Wealth Advisors, alluding to some recent signs of softer economic growth and continued inflation. "To the extent that tariffs remain in place, that will only exacerbate the problem."

It may be difficult for the Federal Reserve to combat stagflation since the Fed usually raises rates when it's worried about high prices and lowers rates when a weaker job market is a bigger economic concern. So its hands may be tied.

With that in mind, investors should be looking for sectors (and stocks) that may hold up better even in the face of a sluggish economy and persistent inflation, said Phillips. He likes financials and industrials, singling out megabank JPMorgan Chase and aerospace manufacturers RTX and Rockwell Automation as stocks that he believes are less subject to macroeconomic concerns. Some technology companies could hold up well also, Phillips said. He owns software giant Salesforce.

He even thinks investors could find some bargains with retailers that may hold up better in a stagflationary world, such as TJX, the owner of discount chains TJ Maxx, Marshalls, and HomeGoods.

Many other consumer-discretionary stocks may be a different story though. Prominent retailers such as Target and Best Buy have warned that they may need to pass on the cost of tariffs to customers. Americans may also need to get ready for even higher food prices at the grocery store.

And Gina Goetter, chief financial officer of Hasbro, recently told Barron's that while the toy maker is reducing exposure to China, it is still watching the trade war situation closely. She suggested that Hasbro may have to increase prices if tariffs on Canada, Mexico, and China remain in effect...and if further reciprocal tariffs kick in against India and Vietnam. "If they stick, we would have to move quickly, " she said.

So investors need to pick their spots carefully with more cyclical stocks and sectors. The Consumer Discretionary Select Sector SPDR exchange-traded fund is down nearly 10% in the past month, for example. That's why Stifel strategists Barry Bannister and Thomas Carroll wrote in a report last week that they recommend "defensive value" sectors such as consumer staples, healthcare, and utilities. They also like gold, which has rallied to near record highs thanks to its status as an inflation hedge.

"The S&P 500 appears to us to have risks skewed to the downside," they wrote, noting that it's mainly due to "a moderate case of stagflation."

Write to Paul R. La Monica at paul.lamonica@barrons.com

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March 05, 2025 14:50 ET (19:50 GMT)

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