Stagflation is Back - Here's What to Do

The market has a way of ignoring risks right up until the moment it cannot. That moment may be getting closer as the situation in Iran continues to escalate with no clear off ramp, no diplomatic solution in sight, and no reason to believe this resolves quickly.

Investors who have spent the past several months chasing momentum and celebrating multiple expansion may soon be forced to contend with a very different set of realities.

Energy risk and the Strait of Hormuz

The most immediate and obvious risk is energy. 20% of global oil and liquefied natural gas flows through the Strait of Hormuz. That is a key part of global energy logistics.

Even partial disruption can raise prices, while a full disruption would create a major shock. Insurance markets are already reacting, and shipping flows are at risk. It does not take a complete shutdown to move prices materially higher; uncertainty and friction can be enough.

Inflation reversal and tighter financial conditions

Higher energy prices can send inflation back to life and slow growth at the same time. Higher crude prices act as a tax on the global economy by pulling spending power from consumers and businesses and redirecting it into the energy complex.

Households pay more at the pump, transportation costs rise, and input costs increase across manufacturing and agriculture. Margins can get squeezed unless companies can pass those costs through, which becomes harder in a slowing economy.

Second-order effects also matter. Inflation, which had been trending lower largely due to falling energy prices, can reverse course. Energy feeds into headline inflation and can work into core measures over time through transportation and production costs.

The bond market may respond quickly as inflation expectations are repriced higher, with yields rising not necessarily because growth is strong, but because inflation risk is increasing.

Stagflationary pressure for bonds and equities

This combination—slowing growth alongside rising inflation risk—can create a stagflationary impulse that is described as toxic for both bonds and equities. Long duration assets may reprice, the term premium can increase, and the long end of the yield curve can move higher even as economic data weakens.

As long rates rise for the wrong reasons, financial conditions can tighten in ways central banks cannot easily offset. Mortgage rates and corporate borrowing costs can move higher, and discount rates used to value equities can increase, raising the cost of capital across the board.

Potential market drawdowns

Real drawdowns can follow as equity valuation multiples contract when rates rise. Earnings estimates may decline as margins compress, creating a headwind for equities.

The scenario does not require a worst-case outcome in the Middle East; it can be triggered by sustained uncertainty and moderately higher energy prices over time. The longer the conflict drags on, the more these pressures can compound.

Portfolio preparation: capital preservation and discipline

The article frames the response as avoiding panic while acting with discipline. It recommends weeding out positions that are not strongly supported, emphasizing concentration in businesses with strong balance sheets, resilient cash flows, and clear value support.

It also argues that stop losses are a tool for capital preservation when the macro backdrop shifts quickly, and that building “dry powder” can help investors take advantage of dislocations if volatility increases and prices overshoot.

Cash is described as optionality, enabling investors to act when others are forced to react.

Trend following and re-entry signals

Another layer of discipline highlighted is trend following. The article suggests monitoring long-term moving averages and market breadth. It notes that when major indices lose their 200-day or 10-month moving averages, it can indicate institutional capital reallocating, and when fewer stocks remain above those levels, the market may be weakening beneath the surface.

The approach is presented as a way to reduce emotion by respecting major shifts in trend: maintaining exposure when trends are intact, and reducing risk when they break. It also describes trend stabilization and improving trends as a framework for re-entry to avoid two common mistakes in volatile markets: holding through declines and staying out during recoveries.

Risk framework

The article summarizes the risk chain as follows: higher energy prices act as a tax, that tax feeds inflation, inflation pressures the bond market, the bond market tightens financial conditions, credit conditions deteriorate, earnings estimates decline, and valuations compress.

It concludes that investors do not need to predict the conflict’s outcome to understand the direction of risk, but instead need a framework to navigate it—staying calm, being selective, respecting trends, protecting capital, building dry powder, and ensuring that any holdings are something the investor would be willing to buy again.