The shadow of stagflation looms over Wall Street: defensive sectors become a safe haven, CPI report may determine the market outlook

Zhitong Finance APP noted that as the shadow of stagflation spreads in the stock market, investors are closely watching the upcoming consumer inflation report to assess the likelihood of this severe economic scenario becoming a reality.

The combination of slowing economic growth and rising price pressures has not yet become the baseline scenario for investors. However, the latest government report shows a cooling in hiring activity and a resurgence of inflation in the service sector, which has begun to dampen market sentiment and exacerbate uncertainty regarding the pace of interest rate cuts. JP Morgan strategists wrote in a report on August 5 that the latest economic data "amplifies the importance of this week's CPI report."

For Karl Schamotta of Corpay, the approach to dealing with stagflation risks is to stick with defensive sectors such as utilities, communication services, and consumer staples, while avoiding growth sectors like consumer discretionary. In his view, an additional challenge comes from balancing inflation expectations with pressure from President Trump for the Federal Reserve to cut interest rates.

Corpay's Chief Market Strategist Schamotta stated, "We are at a turning point in the economy, and the market is indeed filled with uncertainty about the future direction," adding, "What we need to worry about is a Federal Reserve that is no longer focused on its price stability mission allowing inflation to remain at higher levels for a longer time."

Stagflation surprises lead to declines in stock market benchmark indices

Across Wall Street, concerns about a return to 1970s-style stagflation are making economists and strategists wary, believing that the Federal Reserve may keep interest rates unchanged, thereby removing a key catalyst for the stock market. The S&P 500 index, which has risen 8.6% this year, has seen declines following a disappointing jobs report and a rise in service sector inflation earlier this month.

"In a stagflation environment, cutting interest rates without clear evidence that inflation has peaked is dangerous," wrote economists at Bank of America in a report, reiterating the view that the Federal Reserve will remain on hold for the rest of the year even if employment data is weak.

"Stagflation Shock"

Torsten Slok, partner and chief economist at Apollo Management, prefers sectors less affected by macroeconomic uncertainty and tariffs, such as telecommunications, healthcare, utilities, and technology.

Notably, he lists energy as one of the sectors that may be negatively impacted. This sector was a winner during the inflation cycle of 2022, leading the S&P 500 index for two consecutive years as traders sought to hedge against rising prices in the oil and gas industry.

"Tariff increases are typically a stagflation shock—they simultaneously increase the likelihood of an economic slowdown while putting upward pressure on prices," Slok wrote in a report on Thursday.

Brian Jacobson, chief economist at Annex Wealth Management, is optimistic about sectors that exhibit lower volatility and positive business and earnings momentum in this environment, including financials, industrials, and those that behave more like "business essentials." Rather than consumer staple technology companies. He favors Microsoft and Amazon due to their cloud computing businesses.

Of course, Jacobson stated that he does expect market anxiety over stagflation to ease in the coming weeks, as he anticipates that some of Trump's tax cuts may stimulate investment, potentially offsetting weaker employment data in future reports.

At least for now, uncertainty remains high. According to the monthly survey by the Federal Reserve Bank of New York, U.S. consumer inflation expectations rose in July.

Mark Dodson of Birch Tree Capital stated, "We believe inflation is a longer-term cycle." He added that he expects inflation to accelerate in 2026, and that Treasury yields and mortgage rates "may not decline as many expect when the Federal Reserve takes action."