Transcription
Your energy bills are up. Your food shopping costs more. The money you've got sitting in savings is quietly losing its value. And if the economy slows, your job becomes less secure. That's stagflation. And it's one of the hardest economic environments to protect yourself from.
In this video, we'll look at what's driving it, who's most exposed, and also more importantly, what you can actually do about it. This video is sponsored by Lightyear, a UK investment platform with low and transparent fees that offers stocks, funds, and interest on an invested cash.
So, what is stagflation? Well, it's when you get high inflation and weak growth at the same time. Now, normally, and this is the really important bit, inflation comes from too much demand. The economy is running hot. People are spending. Prices go up and central banks can fix that pretty easily. They raise interest rates that cools things down and the problem goes away.
But when inflation comes from the supply side, things like energy shocks, tariffs, broken supply chains that constrains the amount of stuff which we get. Well, then raising interest rates doesn't fix the cause. It just crushes an economy that's already weak. If you cut rates, you feed inflation. If you raise rates, you kill growth.
The 1970s are the textbook example of this. Oil quadrupled in price. Inflation hit roughly 12% in the US and over 24% in the UK. Real gross domestic product or GDP went negative and it lasted, certainly in the UK, the best part of a decade.
Now let's look at how we got here because I think this is important. Stagflation doesn't just happen. Every major episode follows a similar pattern. So firstly, you get a supply side cost shock that hits an economy where rates are already too low and governments have already been spending heavily. And then policymakers make it even worse. And that's because they treat this supply problem as if it's a demand problem.
In the 1970s, Nixon froze wages and prices before the oil embargo even hit. Real interest rates were already negative. Then in 2021 and 2022, central banks held rates at zero while inflation was already running above target and real policy rates hit roughly -5% across the developed economies. The European Central Bank didn't start raising until months after the Fed. Governments rolled out energy price caps that, of course, shielded consumers in the short term but did nothing to fix the structural dependency on imported energy.
Now in 2025 and 2026, tariffs are probably pushing US inflation up by perhaps half a percentage point or more while at the same time dragging on growth. And if you layer an energy shock on top of that, you've got the conditions that historically produce stagflation. So the specific triggers change, but I'd argue that the policy mistakes don't.
Now let's turn to who's most vulnerable because I think this is where it gets really interesting. The UK is probably the worst positioned of any major economy right now. Growth is running at roughly 1%. Inflation's the highest in the G7. And the government imports about 40% of its energy. That's a 24 billion pound annual bill. And net debt is at roughly 93% of GDP. So the Bank of England is stuck. If they cut rates, they risk reigniting inflation. If they raise them, they crush already weak growth.
Japan's in a different kind of trouble. It's got the highest debt to GDP in the developed world, roughly 230%. And it imports over 90% of its fossil fuels. It's also got a weak currency, so that every global energy spike gets transmitted straight into domestic costs.
Now the US has the advantage of being an energy producer, but federal deficits are running at roughly 7 to 8% of GDP and the International Monetary Fund or the IMF doesn't expect inflation back at target until 2027. The Eurozone's got the lowest inflation at about 1.7% but growth is under 1%. So one more energy shock and there's very little buffer. In other words, this isn't a British problem or an American problem. It's a structural vulnerability and it affects every major economy a bit differently.
Now, before we go on to talk about what this means for your portfolio and some of the ways of mitigating those problems, let me mention Lightyear, the sponsor of today's video. Lightyear and I have been working together for a few years now, and I recently announced a closer partnership with them. Just recently, I sat down with Vander, which is Lightyear's UK CEO, to talk about the state of UK investing and why focusing on what you can actually control, like costs and keeping your strategy simple matters so much. By the way, if that sounds interesting, the interview is linked in the description.
Now, Lightyear has always been upfront about costs and they've just made a meaningful change by becoming a direct member of the UK Central Securities Depository. They've improved their infrastructure and they're passing those savings straight to their users. So, what does that mean in practice? Well, you can now trade commission free on both their stocks and shares ISA and general investment account. And they've also cut their FX fee significantly from 0.35% down to 0.1%. Now this makes Lightyear among the lowest cost brokers in the UK. Fund manager fees still apply, but now you can trade thousands of stocks and ETFs at a lower overall cost than before. And if you'd like to try Lightyear, use the code pensioncraft, the name of our channel, to receive up to £100 in a fractional share or ETF in your general investment account. See the link with full terms and conditions in the description below. And as always, investing involves risk and the value of your investments can go down as well as up.
So, what does this mean for your portfolio? Most investors hold something close to a 60/40 portfolio. That's 60% stocks, 40% bonds. And the whole logic depends on stocks and bonds moving in opposite directions. If stocks fall, bonds go up and the portfolio stays roughly steady.
Now, that works beautifully when inflation is demand-driven. But it breaks, and this is a really key point, when inflation is supply-driven. Now if we look at the data between 2000 and 2023, the stock bond correlation in the US was about minus .29. That's exactly what you want. But between 1970 and 1999, which is the stagflation era, it was a positive .35. What's remarkable is what happened in 2022. The 60/40 had its worst year since 1937. Stocks fell roughly 18%, bonds fell roughly 18% as well. And in real terms, after you apply inflation, the portfolio is down about 24% in a single year. In other words, both sides of your portfolio failed at the same time.
Now, I think a lot of people when markets are volatile, the instinct is to sit in cash because it feels safe. But during stagflation, I'd argue that cash is possibly the worst place to be. And that's because it may lose you money in real terms if inflation spikes and rates don't follow it upwards.
In the UK, savers collectively lost roughly £18 billion in purchasing power in 2025 alone. So that means if you had £50,000 in a savings account in 2020, you'd need roughly £60,000 today just to buy the same things. A typical easy access rate, you'd have perhaps £53,000 or £54,000. So that's a real loss of 5 to 6,000 and it never shows up on your statement.
In the US, it's comparable. Cumulative inflation since 2020 has hit about 24%. So a $50,000 balance needs to be about $62,000 just to stand still. There's a behavioral bias here called money illusion. Research from the Bank of Japan found that people actually feel better holding cash at a positive nominal rate even when their real purchasing power is falling. Now, the balance number that you see in your account goes up and that feels good, but what it buys actually goes down. And most people, at least in my experience, don't notice until much later.
So, let's look at what actually works. Schroeders analyzed real returns across different business cycle phases going all the way back to 1973, and I think the results are pretty striking. During stagflationary periods, gold delivered a real return of roughly 22% per year. Broad commodities returned about 15%. Real estate investment trusts or REITs returned about 6.5%. Stocks, that's the broad market, were down around 1.5%.
Now, energy stocks did really well, and that's of course because they effectively own the problem. If oil prices are the source of the shock, oil producers are the beneficiaries. Consumer staples and utilities tended to hold up too because they've got pricing power. People still need food and electricity. Even in a crisis, growth and tech stocks were probably the weakest part of the stock market. And that's because the valuations depend on discounted future earnings and higher discount rates crush those valuations.
Now, there's one important caveat. Inflation linked bonds aren't automatically safe. UK inflation link guilts lost around 47% in 2022. It depends on the duration of the bonds you own, but the average duration is around 21 years. So, rising real yields destroy their capital value. Short duration inflation link bonds or indeed US Treasury inflation protected securities or TIPS, assuming you hold those to maturity. That's the version that actually works. In other words, duration's the villain here, not inflation protection itself.
If you do want to follow what's happening to these indicators in real time, we track UK and US inflation. We also track UK break even rates and guilt yields on the PensionCraft website. And of course, our members discuss exactly these kind of market movements within the community. I'll leave a link to that in the description below.
So, what should you actually do? Well, the first thing if you've got a workplace pension is to check the default fund. Most UK schemes use a lifestyle strategy that tilts heavily into longer duration bonds as you approach retirement. And I think that could be a problem in this environment. If you've got at least 10 years to go, well, it's probably worth looking at whether your scheme offers a growth option with more real asset exposure.
Another thing to consider, if you're in a self-invested personal pension, a SIP or something similar, a 5 to 10% allocation to broad commodities can make a meaningful difference without dominating your portfolio. On bonds, I think the key is to really keep an eye on duration and in this environment perhaps keep to shorter duration. Short-dated inflation linked bonds or even floating rate instruments reprice with the market rather than losing capital as rates rise.
Also, if you've got variable rate debt, things like a tracker mortgage or credit cards, this is probably the environment where locking into a fixed rate might make sense even at a short-term premium. It really depends on how long you think this crisis will last. But even if it does resolve quickly and energy prices fall quickly, these inflation impulses take time to work through the economy. So there could still be a delayed effect.
And finally, and I think this is perhaps the most important point. If you haven't started investing at all, stagflation is actually an argument for starting, not waiting. Remember, even in stagflation, Schroeders found that stocks outperformed cash more often than not in 10 out of 17 stagflation years going back to 1926. So staying in cash isn't a neutral decision. In fact, it may well end up generating a negative real return even though you'd have probably been better off in stocks. Now, of course, stocks will be more volatile, but longer term, and even in these crisis periods, they've actually performed reasonably well. Certainly, in the recovery period that follows, you'd expect something of a bounce.
So, in conclusion, then, I think stagflation is probably the single hardest environment for both households and portfolios, but the evidence is pretty clear. If you sit in cash, that's usually worse than being invested and tilting towards commodities, short duration inflation linked bonds, and pricing power protected stocks. Now, historically, those tilts have made a real difference. So, my view is that it's worth reviewing your exposure now before this regime is fully priced.
Now, don't forget the offer from the sponsor of today's video who's Lightyear. And if you'd like to try their platform, use the code pensioncraft to receive up to £100 and a fractional share or ETF in your general investment account. There'll be a link with the full terms and conditions in the description below. And as always, investing involves risk and the value of your investments can go down as well as up.
So do tell me what you're doing with this crisis. Are you hedging with a broad commodity fund? Are you moving into real assets? Or maybe you're buying inflation linked bonds. Do tell me and I'd be fascinated to read that in the comments. And as always, thank you for listening.