Philip Robotham | Head | Client Group | Schroders South Africa | mail me |
Despite recent diplomatic peace efforts from the US, the US-Israel war on Iran has now entered its fourth week. As a result, the situation remains extremely volatile. Moreover, ongoing Middle East tensions continue to heighten uncertainty across global markets.
As the days pass, the risk of a stagflationary environment increases. In this scenario, low growth and high inflation occur simultaneously. Consequently, this environment creates far-reaching implications for investors. It also affects how different asset classes respond, often in counterintuitive ways.
Prolonged high oil prices move the needle
According to our economics team, oil prices around $90 per barrel significantly alter inflation dynamics. When prices remain elevated, they intensify inflationary pressures. At the same time, they place additional strain on households.
The current energy price spike appears at the petrol pump and on utility bills. Subsequently, it affects food prices through higher fertiliser costs. Therefore, it impacts both inflation and economic growth. These dynamics, combined with persistent Middle East tensions, amplify the stagflation risk.
Despite these developments, oil prices remain elevated. In addition, recent damage to energy infrastructure reinforces this trend. As a result, investors must now consider the longer-term implications of what markets initially viewed as a short-lived geopolitical shock. This shift has direct consequences for portfolio construction.
Asset allocation as stagflation risk increases
Equities still present opportunities for investors in the current environment. Although this may seem counterintuitive, the cyclical backdrop remains supportive. However, investors must differentiate between regional markets.
For example, the US appears less exposed to inflationary pressures from the energy shock. In contrast, Europe and Asia face greater vulnerability. Therefore, US markets may offer more resilience as Middle East tensions persist.
As stagflation risk increases, government bonds appear more vulnerable. They have already experienced significant losses since the Iran/US conflict began. Furthermore, corporate bond credit spreads remain very tight. This limits their ability to absorb additional shocks.
From a commodities perspective, the window for increasing exposure may have closed. Markets have already priced in significant geopolitical risk premiums. In addition, gold’s traditional role as a hedge requires reassessment.
As the probability of stagflation rises, rising interest rate expectations affect gold’s attractiveness. When bond yields increase, the opportunity cost of holding gold also rises. Therefore, investors may find better yield opportunities in other asset classes. These considerations become more important in a climate shaped by ongoing Middle East tensions.
Currency and real estate considerations
Views on the US dollar have shifted. The currency is reasserting itself as a safe-haven asset. Consequently, investors are revisiting their role within portfolios.
The key question now centres on fiscal and monetary policy responses. Before the latest geopolitical shock, markets expected rate cuts. However, recent central bank meetings signal a shift. Authorities now favour a wait-and-see approach, and some are even considering rate hikes. At the same time, the US economy shows relatively strong fundamentals. It also appears more resilient to energy shocks. As a result, these factors support a more positive outlook on the dollar. This trend continues to evolve alongside persistent Middle East tensions.
In global real estate, high inflation and stable or rising interest rates create challenges. Assets with shorter-duration income streams, such as hotels, may face pressure. Similarly, the office sector may weaken due to slower job creation. However, some segments show resilience.
Properties with full cost pass-through to tenants offer stronger protection. These include shopping centres, mobile network operators and mobile tower companies. In addition, high-demand sectors such as aged care, data centres and necessity-based retail provide diversification opportunities.
Prepare, don’t predict
In complex environments like this, investors must remain pragmatic. They still need to allocate capital, regardless of uncertainty. Therefore, the focus should shift from prediction to preparation.
The goal is to build portfolios that remain robust across a wide range of outcomes. This approach reduces vulnerability to any single scenario. It also helps investors navigate volatility driven by Middle East tensions. Our research supports this strategy. Investors who remained invested in the stock market since the early 1990s achieved returns of about 10.5%. This period began when the VIX index, often called the “fear gauge”, was introduced.
In contrast, investors who reacted to fear performed significantly worse. Those who exited the market when volatility spiked achieved returns of about 5.8%. Therefore, emotional decision-making can materially reduce long-term performance.
Overreacting to short-term market panic damages long-term returns. Conversely, historical stagflation periods show that proactive and differentiated strategies can deliver value. Even in constrained economic environments, disciplined investors can still identify opportunities.
