Stagflation is creeping back - here's how to invest now

Stagflation is resurfacing. Here's how to invest without a 1970s playbook.

For many investors, the word stagflation sounds like something best left in an economics textbook.

It may conjure memories of the 1970s when oil shocks, stubborn inflation, weak growth generated a market environment that challenged the standard playbook.

Australia battled double-digit inflation throughout most of that decade.

This story sounds familiar.

The combination of sticky inflation, a softening US labour market and rising fiscal strain across developed economies is pushing that era back into view.

Add a conflict that threatens global energy supply chains and you have a set of conditions that should prompt every investor to ask a serious question: does my portfolio reflect the world as it is, or the world as it was?

Stagflation is an uncomfortable mix.

Inflation stays higher than expected, while economic growth slows and confidence weakens. It is challenging because the usual policy responses can work against each other.

Cutting rates to support growth can risk reigniting inflation. Keeping policy tight to tame prices can put more pressure on households, business activity and markets. For investors, that means there is less room for complacency.

What is stagflation and why does it matter now?

The era of low inflation, strong growth and abundant conviction is behind us, at least for now.

What is emerging instead is a far less comfortable regime, where inflation remains sticky, growth is uneven.

Stagflation appears as the base case, a Goldilocks scenario of low inflation and high growth is not on the cards, with the best case being an awkward middle in which growth is uneven and conviction is low.

Understanding how portfolios performed during the last major stagflationary period can help investors think more clearly about the risks today.

What assets perform best during stagflation?

1. Gold tends to earn its keep when confidence in the broader system starts to erode

Gold was the standout of the decade, rising from around US$35 per ounce at the start of the 1970s to over US$500 by 1980.

Gold has been in the news recently for good reason. In periods of sticky inflation, policy uncertainty and geopolitical tension, gold can behave differently to other commodities because it is also a currency and a store of value.

It has been one of the standout performers in the current cycle, supported by central bank buying, investor demand and a renewed focus on portfolio diversification. Gold, and the companies that mine it, can play an important role when confidence in traditional financial assets is being tested.

2. Real assets matter

In a world where inflation proves sticky, owning assets with some linkage to prices can make a difference.

Toll roads, pipelines, utilities and airports tend to carry revenues explicitly or implicitly linked to inflation - when prices rise, so too, over time, do their cash flows.

In the inflationary period that followed COVID, specifically in calendar year 2022, global listed infrastructure outperformed broader developed market equities.

The logic is unchanged: assets with genuine pricing power, long-dated cash flows and inelastic demand are exactly what you want to own when inflation erodes the real value of everything else.

3. 'Value' companies outperformed

This may surprise investors conditioned by fifteen years of growth dominance, but the logic holds.

When inflation is elevated and discount rates rise, the present value of distant future earnings falls sharply.

Growth stocks, priced on earnings many years out, are disproportionately exposed. Value stocks tend to earn their returns sooner and cluster in sectors, materials, energy, financials, that benefit from inflation rather than suffering under it.

Is today's stagflation different from the 1970s?

It's worth noting that today's inflation has different drivers: tariffs, geopolitical fragmentation and energy supply disruption rather than pure oil shock. Central banks have more established frameworks.

Technology has introduced genuine productivity tailwinds.

But the underlying portfolio logic remains sound.

In periods where inflation is sticky and growth is below trend, owning assets with real cash flows, pricing power and inflation linkage can prove powerful.

Investors can no longer rely on the assumptions that defined the most recent cycles.

Simply riding the benchmark is unlikely to be enough from here.

Over the past five years, benchmark indices in Australia and the US have been driven higher by a narrow group of mega-cap stocks, creating a level of concentration that leaves passive investors more exposed than they may realise.

The next wave of equity opportunities is likely to come from outside those mega-caps, and it will demand a different set of exposures than the last five years.

History may not repeat.

But for those paying attention, it tends to rhyme. And there are opportunities for those who see that.

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