Viking

At the end of the day, investors need to be rational. I agree - overreacting (usually) never end well. I am generally a fan of small incremental change/adjustments over time. I love history. When I look at financial markets over the past 50 years I am amazed at a couple of things: The high level of extreme volatility How many times the dominant narrative has changed Combining these two observations - investors have been given many 'once in a lifetime' opportunities. They seem to keep popping up every couple of years. Starting a thread to discuss stagflation is not about heading for the hills. It is about making money - hopefully big money. “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” – Warren Buffett In times like these, I find playing good defence is more important than playing good offence. An example: I am not sure why anyone would want to own long duration bonds today. Especially the low quality stuff. I love cash right now. The inflation angle is the one I find the most interesting. Are we really are in a regime change period (higher lows and higher highs) moving forward? Brian Bradstreet talked about this at past AGM's. Gundlach said the exact same thing in the video below. Of course, interest rates are the most important input to valuation. If we are in a regime change with interest rates that has profound implications for investors moving forward (just like what happened when interest rates went from 18% to below zero from 1980 to 2020). I am not trying to be chicken little - I don't think the sky is falling. Rather, the opportunity set appears to be shifting at the edges. Maybe it matters in another year or two. Maybe not. Bottom line - be inquisitive. Be open minded. Most importantly, be rational.

Stagflation in the 1970s: A Brief Investment History 1) Macro Setup: Why the 1970s Were Different The 1970s represent the canonical stagflation regime: high inflation, weak real growth, and repeated policy errors. Two defining shocks: 1973–74 Oil Shock (Arab oil embargo following the Yom Kippur War) 1979 Oil Shock (triggered by the Iranian Revolution) Oil prices increased ~4x in the first shock and doubled again in the second. These were classic negative supply shocks. Compounding factors: Collapse of Bretton Woods (end of gold convertibility in 1971) Loose monetary policy early in the decade Wage-price spirals (union strength, cost-of-living adjustments) Stop-go policy cycles (tighten → recession → ease → inflation resurges) By 1980: CPI inflation: ~13–14% Fed funds rate (under Paul Volcker ~20% Real GDP growth: volatile and weak 2) Asset Class Performance Equities (Broad Market): Poor Real Returns Nominal returns: modestly positive Real returns: negative over the decade Two major drawdowns: 1973–74 and 1979–80 Drivers: Margin compression (input costs ↑) Valuation compression (P/E multiples fell materially) Inflation distorted accounting (earnings overstated vs economic reality) Commodities: The Clear Winner Energy, metals, agriculture all surged Oil: ~3 → ~40 USD/barrel across the decade Broad commodities massively outperformed financial assets Mechanism: Direct beneficiaries of supply shocks Pricing set at the margin (inelastic demand) Gold: Exceptional Performance ~$35/oz (1971) → ~$800/oz (1980) One of the best-performing assets globally Drivers: Monetary instability (post-Bretton Woods) Negative real rates (for much of the decade) Loss of confidence in fiat regimes Bonds: Catastrophic Real Returns Long-duration bonds were destroyed in real terms Yields rose from ~6% to ~15%+ Key point: Real Estate: Mixed, but Generally Positive in Nominal Terms Benefited from inflation (replacement cost ↑, rents ↑) But: Financing costs surged Real returns varied widely by geography and leverage 3) What Worked vs. What Didn’t Worked (Especially Early–Mid Decade) Commodities (energy in particular) Gold / precious metals Resource equities Real assets with pricing power Did Not Work Long-duration bonds (worst asset class) Broad equities (negative real returns) Growth stocks (valuation compression) Fixed-income proxies 4) The Best Way to Navigate (With Hindsight) A. Recognize the Regime Shift Early The critical error most investors made: The winners recognized: Bretton Woods collapse = monetary regime change Oil shocks = persistent supply constraints B. Own Real Assets Early The highest-return positioning: Overweight commodities and energy Allocate to gold as monetary hedge Timing mattered: Most gains occurred before inflation peaked C. Avoid Duration Bonds were structurally mispriced for inflation “Income investing” failed in real terms D. Rotate as Policy Tightens By the late 1970s (Volcker era): Real rates turned sharply positive Commodities peaked Financial assets eventually reset The optimal transition: Reduce commodities near peak inflation Gradually add: high-quality equities fixed income (once real yields became attractive) 5) Key Lessons for Professional Investors 1. Stagflation is a sequencing problem Early phase: inflation shock → real assets dominate Late phase: policy tightening → financial assets recover 2. Inflation destroys both sides of the 60/40 portfolio Equities: margin + multiple compression Bonds: real return destruction 3. Real assets outperform—but only temporarily Commodities are front-loaded trades They peak when demand destruction begins 4. Policy credibility is the turning point The regime only ended when: Paul Volcker forced real rates sharply positive Inflation expectations were broken 6) Bottom Line The 1970s demonstrate: The highest-quality investors: Identified the regime early Overweighted commodities and gold before consensus Avoided duration Rotated into financial assets only after real rates turned positive

The war in the Persian Gulf is old news. Time to move on to what its impacts are going to be on the global economy. I think it is pretty obvious that over the next year inflation will be ticking higher and growth will be ticking lower. Of course, the critical question is how much (inflation/slower growth)? Do we see stagflation? That will depend on how long the war goes on and how governments and financial markets respond. Bottom line, this is probably a good time for investors to brush up on stagflation. Or is your perspective that it doesn't matter - thinking about it will simply mess most investors up? Below is a very crude AI generated overview to get the discussion started. 1) What is Stagflation? Definition (precise): Stagflation is a macro regime characterized by the simultaneous occurrence of: Low or negative real economic growth Elevated inflation Deteriorating real incomes / demand From an investor’s lens, stagflation is fundamentally: This is what makes it structurally different from typical inflationary environments (which are often demand-driven and growth-positive). Key economic mechanics Cost-push inflation dominates (energy, food, inputs) Central banks face a policy trade-off (tighten vs support growth) Profit margins compress (input costs ↑ faster than pricing power) Financial assets re-rate due to: Higher discount rates (inflation) Lower earnings expectations (growth) 2) What is War-Induced Stagflation? War-induced stagflation is a specific subtype driven by geopolitical conflict. Transmission channels Energy shock Supply disruption (oil, gas) Sanctions / trade fragmentation → Immediate inflation impulse Commodity shock Food, metals, fertilizers → Broad-based cost pressure Supply chain fragmentation Re-routing, redundancy, inefficiency → Structural inflation Fiscal expansion Defense spending, subsidies → Supports nominal demand while supply is constrained Risk premium expansion Equity risk premium ↑ Credit spreads ↑ 3) Asset Class Behavior in Stagflation (A) Equities Aggregate outcome: Poor (especially in early phase) Why: Margins compress Discount rates rise Earnings visibility deteriorates Relative winners: Energy producers Commodity-linked businesses Select defensive sectors with pricing power (utilities, staples—conditionally) Relative losers: Long-duration growth (tech, high multiple) Consumer discretionary Capital-intensive cyclicals (without pricing power) (B) Bonds Aggregate outcome: Poor initially Why: Inflation erodes real returns Yields rise (especially real yields later) Nuance: Nominal bonds: worst early Inflation-linked bonds (TIPS / RRBs): relatively better Credit: deteriorates (spreads widen) (C) Commodities Best-performing asset class (early phase) Why: Direct beneficiaries of supply shock Pricing set at the margin Hierarchy: Energy (oil, gas) Industrial metals Agriculture (D) Precious Metals Mixed but generally positive Gold: hedge against: inflation geopolitical risk monetary instability Sensitive to real rates If real rates rise aggressively → headwind If financial repression dominates → tailwind (E) Real Estate Ambiguous / bifurcated Positive: inflation linkage (rents) Negative: higher interest rates, weaker demand Outcome: Early stagflation → negative (rates dominate) Later (if inflation persists, rates stabilize) → mixed recovery 4) Optimal Positioning: Beginning of War-Induced Stagflation This is the highest-alpha window—before markets fully price the regime shift. Core principle: Asset Allocation (Early Phase) 1. Commodities: Overweight (core position) Direct exposure (futures / ETFs / producers) Energy bias is critical 2. Equities: Selective / defensive tilt Overweight: Energy Materials Neutral to underweight: Staples (valuation dependent) Underweight: Growth / tech Consumer discretionary 3. Bonds: Underweight duration Avoid long-duration nominal bonds Prefer: Short duration Inflation-linked bonds 4. Precious Metals: Moderate overweight Gold as: geopolitical hedge policy error hedge 5. Cash / Optionality: Elevated High optionality has value in regime transitions 6. Real Estate: Underweight initially Interest rate shock dominates early 5) What to Avoid (Early Phase) This is critical. 1. Long-duration equities High P/E, future earnings-dependent Most sensitive to rising discount rates 2. Long-duration bonds Guaranteed real return destruction 3. Rate-sensitive assets REITs (early phase) Infrastructure proxies 4. Weak balance sheets Refinancing risk increases Credit spreads widen 5. Demand-sensitive cyclicals Autos, retail, housing-linked 6) How Positioning Evolves Over Time Stagflation is not static. It evolves through phases: Phase 1: Shock (War onset / supply disruption) Characteristics: Inflation spikes Growth still appears resilient Markets underreact initially Positioning: Max overweight commodities Reduce duration aggressively Rotate out of growth equities Phase 2: Recognition Characteristics: Growth weakens visibly Margins compress Central banks tighten Positioning: Maintain commodity exposure Increase defensives (cash, quality equities) Begin accumulating: inflation-linked bonds selective high-quality equities Phase 3: Policy Response / Demand Destruction Characteristics: Recession risk rises Inflation peaks (but still elevated) Financial stress emerges Positioning shift: Reduce commodities (they peak early) Increase: high-quality bonds (duration starts to work again) defensive equities Phase 4: Stabilization / Post-Stagflation Characteristics: Inflation falls Growth stabilizes Policy eases Positioning: Re-risk: equities broadly duration Reduce: commodities gold 7) Strategic Framework (Condensed) Think in three layers: Layer 1: Inflation hedge (early) Commodities Energy equities Gold Layer 2: Survival / capital preservation (mid) Cash Quality equities Inflation-linked bonds Layer 3: Recovery positioning (late) Duration Broad equities Key Insight (Most Investors Miss This) They perform best early They peak when: demand destruction begins policy tightening bites By the time stagflation is widely recognized, the easy money in commodities is often already made. 9) Final Synthesis War-induced stagflation is fundamentally a sequencing problem, not just an allocation problem. Early: Inflation dominates → own real assets Middle: Growth deteriorates → protect capital Late: Policy shifts → re-risk into financial assets The highest-quality investors: Recognize the regime early Rotate before consensus Avoid static “inflation hedge” thinking

Here is my take. Early on in the war the US decided they wanted to keep the price of oil as low as possible. What to do? Remove sanctions and release Russian and Iranian barrels into the market. It has had the desired effect - it kept prices lower than they would have been in the short term. The problem with this strategy is it comes at a cost: it enriches the very countries you are fighting in the war. But the problem gets worse. The additional supply also masks the fact that not enough oil is being produced - a significant gap remains. Eventually the shortage hits physical markets - and only gets worse. That is where we are today. We are likely entering the pain point from a supply perspective. So the policy of removing sanctions and allowing Russian and Iranian oil to be sold on the open market provided a short term ‘win’ in the form of lower prices. Why not take Iranian oil off the market today? Because we are entering the severe pain period from a supply perspective - and it would spike prices even more. (The time to take Iranian oil off the market would have been 4 weeks ago when the war started.) It doesn’t look like this whole thing was very well thought out. But we are knee deep in the fog of war. It is possible that the US has a plan that we don't yet see or understand. Or they know something that we don’t know (regime is getting weaker). As a result it is probably dumb to be too convicted in anything one thinks right now.

Here is a good (frightening) summary of the war in the Persian Gulf. Let’s hope this guy is wrong… and we wake up Monday morning to a deal.

You are assuming Iran lets him TACO. Iran is going to exact a very high price (in terms of concessions) to end the war. The US’s partner (Israel) will not be happy if Iran emerges from the war in a stronger strategic position than when they entered. I hope there is a path to regime change in Iran. But that outcome doesn’t look likely to me (and yes I am a novice on the war/region). Does the US/Iran/Gulf countries decide to try for regime change one more time? What a crazy situation.

You assume the US (under Trump) cares what other countries think. It looks to me like Trump decides what he wants - and then tries to take it. My guess is we will be seeing much more of this moving forward. He will, after all, need to manufacture a distraction soon, to get everyone to think about something other than Iran (hat tip to @dealraker for that last line).

Well it looks like financial markets are just starting to grasp the significance of what is happening in the Persian Gulf: Bond yields across the curve have been slowly marching higher (50 to 60 basis point increase) over the past 4 weeks. Inflation will be increasing in the coming months - the only question is how bad it is going to be (how much and how long it persists). Depending on the average used, stock markets are down almost 10% from their recent all-time highs. A decline of 10% would officially put is in ‘correction’ territory. Of course, there is a lots of variation by sector (software stocks compared to oil & gas stocks). Of course, rising bond yields AND much lower stock prices means everything is dropping in value. But here is where the story gets even more interesting… The cause of the carnage happening in financial markets has not been addressed yet : Iran controls the Straight of Hormuz. As a result the global economy continues on its merry way towards a cliff. Every week the straight remains closed the worse the damage becomes. This has been playing out for 4 weeks now. Right in front of everyone. The really interesting part to me is how complacent everyone has been about what is happening. Although that does appear to slowly be changing. Where do we go from here? I have no idea. A good place to start might be to get familiar with Iran and what they want. They have laid out their terms. Now we can refuse to live in the real world and ignore Iran (what we have been doing for the past 4 weeks). But as we all know denial is a river in Egypt - not a good strategy to use today. The key question today is: How much pain does Iran want to exert on the US/Israel and the global economy? Put yourself in their shoes for a minute. Pretend you are the IRGC. What would you want to do right now? If that doesn't scare the hell out of you nothing will. (Like I said earlier… you might want to get familiar with their terms.) To state the obvious: I am not ‘cheerleading’ the IRGC. Or how the war is going. I am trying to understand what has happened, where we are at and most importantly where we might be going. As uncomfortable as that might be for some… PS: Trump is a change agent. The geopolitical world was already quaking. This war has the potential to accelerate this process. (Can anyone say ‘every man for himself?’)

If boots don’t hit the ground where does oil go?

@Gregmal, you ask a great question. My view is investors are (generally) much better off simply ignoring macro. @dealraker is the master of this approach. Having said that, I also think there are times when it makes sense to pay attention to macro. Of course, because this is something that I do doesn’t mean this is something that others should do. That is why I started a separate thread on this topic. People can read my thinking there - so I won’t repeat it here. My ‘hair on fire’ comment was in response to @cubsfan hyperbole. My view is if the Straight of Hormuz remains closed for another month it will likely tip the global economy into recession. At the same time it will likely spike inflation - which will spike interest rates. If the straight remains closed for longer the impact on the global economy will be worse. The fact that there have been no historical parallels matters - we are in uncharted waters. I have said repeatedly, my goal is capital preservation. Not return. Stock markets are a couple of percent from all time highs. I don’t like the risk reward set-up. So my solution is to shift a chunk of my portfolio to cash. And then closely monitor the situation (hence my frequent posting on the topic). Part of my problem is I also love political science/economics/business/investing. Like a moth attracted to a flame, I am attracted to macro… Over the years it has served me very well (yes, in this regard I know I am a different duck).

@cubsfan, can you please share your thoughts on the Straight of Hormuz? Is it important? Who controls it today? When will it open to free flowing traffic? My view is if the Straight of Hormuz remains closed for another month the global economy will have its ‘hair on fire’ moment. What do you think?

In a war it is important to separate signal from noise. The central question of this war is “Is oil/LNG/refined products/fertilizers freely flowing through the Straight of Hormuz?” That is signal. Everything else is noise. Every day they stay in control of the straight improves Iran’s position. When physical shortages show up in another 2 or 3 weeks - the global economy is going to going to have its come to Jesus moment. Iran knows this. The US also knows this. The US has unwittingly made Iran more economically powerful than it has ever been before. It controls the straight. And with sanctions lifted, the gold is now rolling in. Yes, Trump is a genius. And look at Russia… sanctions lifted and oil prices going higher - gold is filling up their coffers. And guess who is helping Iran militarily? Russia. The US is lining the pockets of the country that is helping the IRGC take out Americans. Diabolical. This whole operation is getting ugly. And it looks like it is about to get worse.

"Escalation trap?" Let's hope this guy is wrong. He talks about the difference between the military operation and the politics. And how one changes the other.

@cubsfan, I hope we find a way to de-escalate out of this war. But all I am seeing is the opposite - escalation. I know… the justification for the escalation is always to bring an end to the war. But history teaches us that the opposite is usually what happens. Meanwhile, every week this war continues the closer the global economy comes to its Wiley Coyote moment. There is a time element to this war that is becoming more and more important - and it is working in Iran’s favour (and they know it).

I think this indicates the war may be about to escalate. What does that mean? We don’t know. That should scare the hell out of people. (Remember ~20% of oil, LNG, refined products, fertilizer comes from that region… critical infrastructure like desalination plants... Blowing everything up would not be a good thing for the people of the region or the global economy.)

Both sides think they are winning. They despise each other. They don’t trust each other. And you think we are going to get a negotiated settlement? I hope you are right.

Ok. So if you are Trump and things aren’t going well what do you do? Of course you punt the problem to someone else. On the invasion of Iraq, Colin Powell famously told President George W. Bush, "If you break it you own it." The new Trump doctrine: “When I break it you own it.” So who does Trump punt the problem to? This is where the current situation gets interesting. The Gulf states are one obvious answer - but this would likely permanently impair US/Gulf relationship. Oil importing nations in Asia is another obvious answer. The optics of this war are also really bad: The US can be viewed as a (relative) winner. The rest of the world is the loser. And then exiting the problem? Ouch! But here is the biggest problem Trump might have moving forward: you can lie to the rest of the world all you want. But you can’t start a war and then lie to the American people. Especially if the war is not going well. There are so many interesting angles to this story…

Here is what sounds like a pretty balanced perspective from the head of MI6 of where the war is at. Q: “Who has the upper hand?” A: “Iran.” ”I regret coming to this conclusion.” (This guy can’t stand the IRCG.) “The US underestimated the task. As about two weeks ago lost the initiative to Iran.” He explain why in detail why he thinks this. (PS: If this guy thinks this guess what the IRGC thinks?)

@Parsad, there is no risk of 100,000 US casualties any time soon. So that problem is off the table for now. I think you are underestimating Iran’s resolve. Look at what they were willing to endure in their decade-long war with Iraq (the military leaders from that war are in charge now). We are 4 weeks into this conflict. The IRCG want much more than to ‘retain power and control.’ As long as they control what gets out of the straight they have leverage - it makes sense to me that they are going to try and maximize it. I agree that at some point Trump might decide to use a tactical nuke… Game theory only really works when you are dealing with rational actors. The US under Trump and Iran under the IRGC are not rational (I don’t think that should be a controversial statement).

Iran doesn’t need to ‘fight back.’ IMHO, what matters in this war today is very simple: the Straight of Hormuz. Iran appears to be in ‘control’ of the straight. By control, they appear to be the party controlling what gets in and out. The question everyone wants answered: “When will traffic in the Straight of Hormuz return to normal?” I don’t think anyone is questioning the awesome power of the US military. Or how much it can bomb Iran. That is pretty obvious. The issue is - despite this awesome power - the straight remains effectively closed. Yes, it is a contradiction.

“Everybody's got a plan until they get punched in the face" - great philosopher Mike Tyson I find tail risk so interesting because really bad things do happen. The key is to be as rational as possible (which includes being honest with youself). But ‘rational’ is not absolute (what people like me and other board members might post with great confidence should be done). It is relative (what you actually will do when the punch lands).

Asia is being impacted in a major way by the war in the middle east. This makes sense - it is the region where most of the output from the Persian Gulf was going. But markets are global. Should the war continue, the rest of the world will be increasingly impacted. Below is an article that reviews a note from JP Morgan that reviews the impacts on Asia. There is a parallel here - and that is Covid. When Covid hit, it started in China, a week later it hit South Korea, and then a week later it hit Italy, and then a week later it hit Washington State. North America got a preview by a couple of weeks of the shit storm that was coming. Of interest, financial markets completely ignored it. Until it became impossible to ignore. It looks to me like a similar dynamic is playing out today. The difference is this developing crisis is man made. As a result, the solution is much easier than Covid - it doesn’t require the world to discover a vaccine. So we will get a solution. The only question is how quick it comes. Absent regime change in Iran, my guess is it will be economic pressure that drives the solution. And the economic pressure today is apparently not severe enough (the Straight of Hormuz remains closed). But as we can see from the article below, it is clear the economic pressure is ramping up. So I am optimistic that a solution is coming. Yes, crazy times. ————— Energy: JPMorgan warns demand destruction has already begun (and models aren’t measuring it properly) https://www.shale24.com/en/oil-gas/energy-jpmorgan-warns-demand-destruction-has-already-begun-and-models-arent-measuring-it-properly-n809/amp In an Oil Flash Note, the bank’s Global Markets Strategy team estimated that the price effect of crude on global demand would trim just 1 million barrels per day in April. But there is a second form of demand destruction that standard elasticity does not capture: the one that occurs when physical inputs simply do not arrive. JPMorgan documented it company by company in Asia and concluded it is already underway. JPMorgan does not typically title its market notes with statements in the present tense. The Oil Flash Note from its Global Markets Strategy team carries a subtitle that leaves little room for interpretation: demand destruction has already begun. Not “could begin.” Not “is at risk.” It has already begun. The bank devotes the document to explaining why standard financial models are underestimating it. The core argument hinges on a distinction that may seem technical but has direct market implications. There are two types of demand destruction. The first is what elasticity models capture: when prices rise enough, consumers adjust. The second occurs when physical inputs do not arrive regardless of the price buyers are willing to pay—what JPMorgan describes as demand destruction driven by the physical absence of inputs. That is what has been unfolding in Asia since mid-March, and it is what standard financial models fail to capture.

Great podcast on the impact of the war in the middle east on plastics. the impact to date has been modest. But in about 2 to 3 weeks the impact could be severe. In other words, we are getting to an inflection point. Plastics is interesting because of the demand destruction aspect. If jet fuel spikes in price, air fares spike and people fly less - reducing demand. The problem with plastics is for many uses like food packaging there are limited substitutes. When packaging prices spike the cost of the food item goes up. But people don’t eat less. There is limited demand destruction - which makes the problem worse. A medium term impact is supply from the middle east will likely carry a risk premium. This should result in more production shifting to the US. It is pretty obvious that the longer the war goes on the more Iran’s position improves and the more the position of the US deteriorates. The past 4 weeks have been foreplay. Things are about to get spicy in the next 2 or 3 weeks. Oil, LNG, refined products/plastics, fertilizers… all matter to the global economy. A lot. The rational thing for Iran to do would be to delay - keep the straight closed. The rational thing for the US to do would be quick resolution - open the straight. What is priced in to financial markets? A quick resolution. Trump is the master at pivoting - he has been Houdini-like in escaping from what appear to be tight spots. Hopefully he can work some magic this weekend. If not… financial markets might get their Wiley Coyote moment.

@Xerxes, I am slowly coming around to the realization that I do not understand the Persian Gulf/middle east very well. I am trying to get a better handle on Iran - how do they view the war? What are their objectives? What might have changed this time around? I found the following video interesting. If it is remotely accurate, it looks to me like the war is likely just getting started. And that is not on anyone’s bingo card. Right now everything I read is looking at the conflict through the US/Israeli/arab lens - and completely ignoring the Iran perspective. The implicit assumption is Iran will be the price taker with the US/Israeli’s/arabs being the price setters. I think the West is likely underestimating Iran - its resolve and the amount of leverage it thinks it has (controlling the straight and the ability to take out the critical infrastructure of its neighbours). They view what is going on today as part of a 47 year war. But one in which they need to use new tactics (the old tactics clearly have not worked). The new tactics part is what is not understood (yet) in the West today. Time will tell. But I am thinking we could see the war escalate this weekend.

When I read the reports of some analysts like the guy at Morningstar I can’t help but think of the following video (with the management team at Fairfax being represented by Dave Grohl and the Foo Fighters).