Money%20Illusion

The Toxic Duo of High Prices and Stagnation Stagflation represents a unique economic paralysis where high inflation and weak growth collide. Unlike demand-driven inflation, which central banks cool by raising interest rates, stagflation usually stems from supply-side shocks like energy spikes or broken trade routes. When growth is already fragile, raising rates to fight inflation risks crushing the economy, while cutting rates to stimulate growth only fuels the fire. This creates a policy trap that can last a decade, as seen during the 1970s oil crisis. Why Your Diversified Portfolio is Failing The traditional 60/40 portfolio—comprising 60% stocks and 40% bonds—relies on a negative correlation between the two asset classes. In normal times, when stocks fall, bonds rise. However, during stagflation, this relationship turns positive. In 2022, both stocks and bonds dropped roughly 18% simultaneously, resulting in a real-term loss of 24%. When inflation is supply-driven, bonds lose their hedging power, leaving investors with nowhere to hide in a conventional allocation. The Psychology of the Cash Trap Many investors retreat to cash during volatility, falling victim to "money illusion." While your bank balance may stay the same or grow slightly, your purchasing power evaporates. Ramin Nakisa notes that UK savers lost approximately £18 billion in purchasing power in 2025 alone. A £50,000 balance from 2020 would require roughly £62,000 today just to maintain the same standard of living. Sitting in cash during a high-inflation regime is not a neutral act; it is a guaranteed real-term loss. Practical Hedges for a New Regime To survive this environment, portfolios must tilt toward real assets. Historical data from Schroders suggests that during stagflationary periods, Gold has delivered real returns of 22% per year, while broad commodities returned 15%. Within the stock market, energy firms and consumer staples offer protection because they possess pricing power. Crucially, investors should avoid long-duration bonds, which are highly sensitive to rising yields. Short-dated inflation-linked bonds or floating-rate instruments provide a more resilient path for fixed-income exposure.