In focus

How does stagflation impact investment returns?

The first half of 2021 saw a strong rebound in economic growth alongside rising inflation.

However, growth momentum is already showing signs of slowing down as fiscal and monetary stimulus fades. Meanwhile, inflation remains elevated due to supply-chain disruptions and soaring energy costs.

Taken together, concerns are brewing that a stagflationary environment – one of low growth but high inflation – may be unfolding.

So, how should investors prepare for this possible scenario? Our analysis reveals which asset classes are likely to outperform if it comes to pass.

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Business cycle phases

In general, there are four different phases of the business cycle based on the evolution of output and inflation: goldilocks, disinflation, reflation and stagflation.

However, it can be tricky to evaluate asset class behaviour during each phase because markets are forward-looking while conventional measures of economic growth such as GDP are published with a lag and may therefore inadequately capture pre-emptive asset flows.

As a result, we proxy growth using the US Conference Board Leading Economic Index (LEI), which is designed to signal turning points in economic data more effectively than GDP.

Another challenge is that there is no universally accepted definition of what level of growth and inflation constitutes stagflation. So in order to maximise the number of historical data points, we define stagflation as any month where growth (LEI) is falling and US core CPI inflation is above its 10-year average on a year-on-year (YoY) basis. Defining it based on other thresholds (e.g. slowing growth and inflation above 3%) do not significantly alter the results presented in the next section.

From reflation to stagflation, winners and losers fluctuate

The table below shows the average real (inflation-adjusted) YoY total return of major asset classes since 1973 (see footnote for the full business phase definitions).

Clearly, the best and worst performers vary considerably across each phase and the dispersion of returns within in each phase has also been stark.


For example, the top performers during periods of stagflation have been gold (+22.1%), commodities (+15.0%) and real estate investment trusts (REITs) (+6.5%). Equities have tended to struggle (-1.5%).

This makes sense. Gold is often seen as a safe-haven asset and so tends to appreciate in times of economic uncertainty. Real interest rates also tend to decline in periods of stagflation as inflation expectations rise and growth expectations fall. Lower real rates reduce the opportunity cost of owning a zero-yielding asset such as gold, thereby boosting its appeal to investors.

Commodities (for example, raw materials and energy) are a source of input costs for companies as well as a key component of inflation indices. So, they will typically perform well when inflation rises too (often because they are the cause of the rise in inflation). However, returns are weaker compared to reflationary periods, where they benefit from the additional tailwind of rising economic demand.

Similarly, REITs offer a partial inflation hedge via the pass-through of price increases in rental contracts and property prices.

Although reflation has tended to be positive for equities (+14.6%), stagflation has proved more challenging (-1.5%), as companies combat falling revenues and rising costs.

Treasury bonds are a mixed bag. In theory, they should benefit from falling real rates, driven by declining growth. However, rising inflation eats into their income, putting upward pressure on yields and downward pressure on prices.

In practice, the extent to which this harms bond returns will depend on their duration and starting yield (higher yields provide a larger cushion to absorb rate rises). The historical data reflects this complex interplay of factors - Treasuries have delivered low but positive annual real returns (+0.6).

What are the key takeaways for asset allocation?

Over the last six months, the reflation environment has favoured investing in risk assets such as equities and commodities, while gold has suffered.

This is consistent with what we would expect using our above analysis. However, if we are on the cusp of a period of stagflation, then a shift in performance leadership may be on the way.

In this scenario, equity returns may become more muted while gold may see increased demand as investors seek refuge in safe-haven assets.

Commodities and REITs are attractive alternatives given their inflation-hedging potential, although the historical evidence suggests returns are likely to be more modest in comparison. 

The outcome for Treasuries is somewhat uncertain and will depend on the tug-of-war between inflation and growth sentiment.

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