The Stagflation Trap | Aahan Menon on What Works When Stocks and Bonds Don’t

Unprecedented macro divergence

The economy shows mixed signals unseen in modern history: labor markets slow while output remains elevated due to AI capex, and consumers spend through disaving despite weak income growth.

Energy shock as recession catalyst

Sustained oil price spikes from Middle East conflict are creating month-to-month annualized CPI readings 'in the nines,' acting as the recessionary trigger that tariffs failed to deliver.

Vulnerability window widening

Consensus expectations have overshot economic reality, creating fragility that existed even before recent geopolitical shocks and threatens to tip output into contraction.

The 1965-1985 precedent

Sustained inflationary periods produce asset returns opposite to recent decades: equities meander, fixed income performs terribly, while gold and commodities become the assets to own.

Portfolio design mismatch

Most investors remain constructed for disinflationary real growth with heavy equity-bond allocations, leaving them unprepared for a regime where these assets 'aren't designed to perform.'

Preparation over prediction

The critical question is not whether stagflation will occur, but whether portfolios are ready to handle sustained inflationary pressures bleeding from energy into other sectors.

Current return rankings

Commodities—particularly energy—offer the highest expected returns today, followed by FX interest rate differentials, while equity and fixed income expected returns remain weak relative to risk.

Volatility-adjusted fixed income

While fixed income opportunities are emerging, energy-driven volatility makes the risk-adjusted returns unattractive compared to other asset classes.

Smart beta methodology

Expected returns are calculated using forward earnings yields (equities), yield curve shape (bonds), term structure (commodities), and interest rate differentials (FX) to create an adaptive global baseline.

Counterintuitive value creation

Unlike stocks and bonds where lower prices signal higher value, commodities generate best risk premiums during supply shocks when backwardation occurs and spot prices rally.

Backwardation mechanics

During supply shortages, buying oil futures 6-24 months out captures convergence to higher spot prices, creating intense positive skew exactly when traditional portfolios suffer.

Trend following synergy

Commodity carry and time-series trend strategies become highly correlated during crises, making trend-following overlays particularly effective for capturing pro-cyclical commodity exposure.