The Resurgence of Stagflation Fears
Stagflation fears are resurfacing, creating a challenging environment for investors who must now look beyond traditional investment strategies to find returns. This phenomenon, characterized by high inflation, low growth, and high unemployment, is reminiscent of the 1970s and is driven by factors such as oil price shocks. The current economic landscape echoes that of the past, with global economies facing similar pressures.
Last week, I highlighted the need for investors to prepare for a potential return of stagflation. The 1970s saw many developed economies, including Australia, the US, Canada, Western Europe, and Japan, grappling with this issue. It marked the end of the post-war economic expansion and could be on the horizon once again.
Recent flash PMI data indicates a shift in economic activity. In the Eurozone, business activity has slowed significantly, with the headline index just above the contraction threshold at 50.5, down from 51.9 the previous month. This slowdown is exacerbated by escalating tensions involving Iran, which directly affects oil prices, shipping routes, and supply chains, pushing costs higher across continents.
Global Impact of Stagflation
The effects of these tensions are not confined to one region. From Europe’s manufacturing base to Asia’s import-heavy economies and Australia’s exposure to global commodity cycles, a similar pattern is emerging: higher input costs colliding with softer demand. This combination is increasingly familiar, indicating a shift from a risk scenario to a credible global trajectory.
This backdrop presents unique challenges for investors, as it undermines the assumptions that underpin traditional portfolio construction. Growth assets depend on expanding earnings, while bonds rely on stable inflation and predictable policy direction. Cash assumes purchasing power can be preserved. However, stagflation weakens each of these simultaneously.
Navigating the Challenges
The result is not necessarily dramatic market collapses, but something arguably more frustrating – markets that move without progressing. Across the US, Europe, and parts of Asia, equity indices are showing signs of this dynamic. Corporate margins are being squeezed by higher energy and input costs, while consumers become more cautious.
In Australia, the situation carries an additional layer. The economy is deeply tied to global demand for commodities, particularly from China, yet it is also sensitive to imported inflation through energy and supply chains. A slowdown in global growth alongside elevated price pressures places the country in a delicate position, with domestic markets reflecting that tension.
Why Portfolios Struggle in Stagflation
In this kind of environment, investors are forced to work harder for returns. Strong directional gains become less reliable, while traditional defensive assets struggle to deliver real protection. Portfolios can appear stable in nominal terms while quietly losing ground after inflation. Standing still carries a cost.
This is where investment behavior begins to evolve. In strongly rising markets, participation is the priority. In downturns, preservation dominates. Stagflation sits between the two, requiring a more deliberate approach. Investors begin to look for ways to generate return from movement itself, rather than relying on a clear upward trend.
Structured notes are increasingly part of that shift. Their relevance comes from their ability to reshape how returns are generated. Rather than depending on markets to rise, they allow investors to define outcomes based on specific conditions. In a world in which indices are likely to trade within ranges, this becomes a meaningful advantage.
A Different Way to Generate Returns
One of the key attractions is the ability to generate income in markets that lack momentum. Structures such as autocallables can deliver enhanced coupons provided an underlying index remains above a certain level. In a flat market, where sharp declines are intermittent rather than sustained, these conditions can be met more frequently than many expect. The outcome is income derived from stability within a range, rather than from outright growth.
Volatility, which tends to increase in stagflationary periods, also plays a central role. Markets react to shifting inflation data, policy signals, and geopolitical developments with greater sensitivity, producing more frequent price swings. For conventional portfolios, this can be destabilizing. Within structured products, it can be harnessed. Higher volatility feeds into option pricing, supporting more attractive coupon levels. Investors are compensated for taking on defined risks in an uncertain environment, effectively turning volatility into a source of return.
Managing Risk in a Volatile Cycle
Downside considerations are equally important. Stagflation rarely produces a single, clean drawdown followed by recovery. More often, it delivers a sequence of declines and partial rebounds. Structured notes that incorporate buffers or conditional protection offer a way to remain invested while limiting exposure to moderate losses. Accepting a cap on potential upside in exchange for a degree of protection aligns with the more cautious positioning many investors are adopting globally.
The flexibility to target specific exposures adds further appeal. Structured notes can be linked to assets that may hold up relatively well in inflationary conditions, including energy producers, commodity-linked equities, or broader indices with strong pricing power. This is particularly relevant for regions such as Australia, where resource sectors play a central role, as well as for markets in Asia that are closely tied to global trade flows. At the same time, the structure can embed income or protection features that help offset the challenges posed by weak growth.
Why It’s Gaining Traction
None of this removes the need for careful analysis. Structured notes introduce layers of complexity, and outcomes depend on clearly defined terms that must be understood in detail. Issuer strength is critical, as returns are contingent on the creditworthiness of the institution behind the product. Liquidity can also be constrained, especially during periods of market stress.
These factors require disciplined assessment and appropriate sizing within a broader portfolio. Demand tends to rise because the alternatives are increasingly constrained. A portfolio relying solely on equities, bonds, and cash faces structural pressure in a stagflationary world. Equities may struggle to generate sustained gains, bonds may fail to preserve real value, and cash steadily erodes in purchasing power. Investors are compelled to think more precisely about how returns are generated.
Structured notes offer a way to respond to that challenge by aligning investment outcomes more closely with prevailing market conditions. They allow investors to extract value from range-bound markets, to make use of elevated volatility, and to shape risk exposure in a more controlled way. In a global environment defined by persistent inflation, uneven growth, and geopolitical uncertainty, that flexibility carries weight.
The broader point is that the current phase of the cycle demands adaptation. The global nature of the pressures – from energy markets influenced by Middle East tensions to growth slowdowns in Europe and shifting dynamics in Asia and Australia – means that no region is insulated. Markets are likely to continue moving without clear direction, and portfolios built for a different environment will struggle to keep pace.
Investors who adjust their approach accordingly are better positioned. Generating returns in this setting requires more structure, more intentionality, and a willingness to move beyond traditional frameworks. As the risk of prolonged stagflation builds, instruments designed to function in precisely these conditions are likely to move closer to the centre of portfolio construction.
