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What started as a trickle several weeks ago has turned into an almost daily deluge of headlines about the risks to the US economy from an approaching period of stagflation.

Today, we’re going to discuss some of the current risks that could in fact cause stagflation to become an issue, and we’ll examine whether such a development could lead to any bullish opportunities in one of the few sectors that tend to outperform in these types of environments.

What is stagflation?

Stagflation is defined as a period of high inflation, stagnant economic growth, and high unemployment.

Although the US economy is not yet faced with high unemployment or stagnant economic growth, stagflation often begins with policymakers having to implement tools to combat high inflation (which is becoming an issue), which ultimately causes unemployment to rise and economic activity to stagnate.

So, yeah, the concerns are valid.

What’s happening now that could cause stagflation to materialize?

First and foremost, bottlenecks that are currently shifting from one part of the supply chain to another could cause inflation to stay stubbornly high for the foreseeable future.

While US Federal Reserve officials have previously claimed that the current bout of inflation is “transitory,” more recently they have become increasingly accepting of the idea that inflation has been stickier than previously thought.

This acknowledgment comes as prices of the “stuff” we need to survive in everyday life, like food and energy, have been rising faster than wages and eroding the purchasing power of Americans.

Which sectors tend to do well during stagflation?

During periods of stagflation, of the 11 official S&P 500 sectors that tend to outperform, consumer staple, healthcare, and utilities typically fare the best.

Why?

Because consumers can’t easily cut spending on staples such as food (think supermarket items, not fast food), medicine, and electricity.

For today’s discussion, I’m going to focus on the consumer staples sector, leaving the healthcare and utilities sectors for subsequent discussions in the days ahead.

What does the consumer staples sector look like, technically?

From a technical perspective, the consumer staples sector, measured here by the S&P 500 SPDR Select Sector Fund (XLP), has been beaten down of late.

Although the XLP’s 5.2% decline is almost as much as the S&P 500’s 4.6% drop since printing an all-time high close on 09/02, the XLP has only gained 2.0% for the Y-T-D period vs. the S&P 500’s +14% Y-T-D performance.

Technically, though, XLP is finally starting to come into some support that looks interesting because there is a lot of it.

Specifically, as Figure 1 shows, XLP is about to test its rising 200-day moving average and a congested former resistance turned support area dating back to November of last year.

This is happening as momentum, measured here by the default 14-day RSI indicator, is now at oversold levels that have preceded the start of recent rallies.

Figure 1

Keep in mind that when using a long-term moving average like the 200-day moving average, declining prices do not always stop right at this line.

This is  a long-term “smoothing” line that prices can often slip below before they stabilize.

That’s why, in situations such as this, I like to open my anticipated support zone a bit to help me in instances when I am trying to establish a trading plan to enter a long position.

In terms of the companies that can be found within this sector, the one stock I want to pay attention to is good-old Coca-Cola (COKE).

When it comes to trying to find companies that have better odds than the competition to outperform during periods of stagnating economic growth, the key is to find strong brands whose products are likely to remain in demand and whose management can negotiate with suppliers for more favorable pricing.

Coca-Cola is one of those companies.

From a technical perspective, Figure 2 shows shares of COKE consolidating within a “descending triangle” pattern.

Figure 2

Now, you might be saying to yourself that this pattern looks a lot like what we would call a “bull flag.”

While this pattern does resemble what a “bull flag” could look like, once the time that it takes a “bull flag” to develop starts to extend beyond 3 months, the textbooks tell us that we need to start thinking of it as a “triangle” pattern.

IF COKE shares are indeed setting up for a new leg higher, supported by investors who see the potential for leadership in a stagflation environment, this consolidation/pause within the longer-term uptrend is exactly the kind of development that would support this thesis.

As figure 2 shows, this setup makes establishing a bullish trading plan easy, because we know what the potential target is and what the stop-out level is.

Specifically, as long as the bottom of this pattern remains support, a trader who likes this idea enough to implement a bullish trade needs to be buying against pattern support.

Only when pattern support fails to attract new buyers with this thesis break down and force bullish traders out of the trade.

Author:
Jason Bond

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