By Andrew Lakeman, Atlantic House Co-Founder
Stagflation – the uncomfortable coexistence of rising prices and slowing growth – is a topic being raised by investors and clients alike. While many associate it with the oil shocks and policy missteps of the 1970s, its relevance today is undeniable. Supply chain disruptions, deglobalisation, and rising fiscal deficits have combined to create conditions where stagflation is no longer a remote possibility, but a scenario that advisers must seriously consider when constructing resilient portfolios.
For many, the term itself brings discomfort – and rightly so. Stagflation is notoriously difficult to navigate. It challenges some of the most basic assumptions about diversification. Historically, the cornerstone of portfolio resilience has been the balance between equities and bonds. Equities have offered the potential for long-term growth, while bonds have provided protection during periods of market stress, typically benefitting when economic slowdowns lead to falling interest rates.
Stagflation, however, disrupts this dynamic. With inflation rising and economic growth stalling, bonds lose their protective qualities. Higher inflation pressures central banks to keep interest rates elevated or even raise them further, eroding bond prices just as growth-sensitive equities also suffer. For advisers, this created a daunting prospect: portfolios that may appear diversified on paper yet behave uniformly under stress.
Moreover, inflation-linked bonds, often cited as the natural hedge in these scenarios, are not a cure-all. While they can offer inflation protection, their long duration can expose them to significant capital losses if real yields rise abruptly – precisely the kind of scenario common in stagflationary environments. Many advisers witness this first-hand in recent years when inflation expectations rose but were accompanied by sharp moves higher in real yields, leaving inflation-linked bond allocations underwhelming.
Faced with this challenge, the question is not whether diversification is still available – it undoubtedly is – but how to diversify effectively. In stagflationary environments, traditional approaches need to be complemented by strategies designed specifically to respond to this kind of uncertainty.
Systematic strategies, for example, that dynamically adjust between interest rates and inflation-linked instruments offer a more nuanced approach than a static duration management. By focusing on inflation trends rather than relying solely on interest rate forecast, these strategies can help shield portfolios from the double blow of rising inflation and stagnating growth.
Additionally, trend-following strategies, often overlooked in conventional portfolios, have historically fared well in inflationary and stagflationary periods. By systemically capturing persistent price trends across asset classes, they offer a valuable source of diversification when equities and bonds are both under pressure.
Also read: US Triangular Correction; Rate Volatility is Back; Spotting Safe-Havens
Outcome-orientated strategies that aim to deliver defined or asymmetric return profiles can also play a meaningful role. In a stagflationary world, where markets may drift lower or exhibit bouts of volatility without a clear direction, strategies that accept a capped upside in exchange for a higher probability of meeting specific return targets can significantly improve the robustness of client outcomes.
For advisers, stagflation presents an opportunity to revisit portfolio construction with a sharper lens. It reinforces the importance of aligning investment strategies not just to long-term growth assumption, but to the possibility of challenging and unconventional environments. The goal is not to build portfolios that work in an ideal world, but to build ones that are prepared for the world as it is – unpredictable, sometimes uncomfortable, and always evolving.
While stagflation is by no means inevitable, its potential is a reminder that portfolio resilience comes not from trying to predict the next market move, but from preparing for a wide range of possible outcomes. For clients, this assurance that their portfolio can navigate these environments is invaluable.
