Are global markets heading towards stagflation?

Key Concepts

• Stagflation: An economic regime characterized by stagnant economic growth, high unemployment, and high inflation.
• Reflation: A fiscal or monetary policy designed to expand output and stimulate the economy, typically characterized by high growth and high inflation.
• Correlation Risk: The tendency for different asset classes (like equities and fixed income) to move in the same direction, reducing the effectiveness of traditional diversification.
• Supply Shock: An unexpected event that suddenly changes the supply of a product or commodity, leading to price volatility (e.g., energy/food price spikes due to geopolitical tensions).
• Alternative Assets (Alts): Non-traditional investments (commodities, infrastructure) used to provide diversification when traditional stocks and bonds fail to hedge against market volatility.

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1. Macroeconomic Outlook: Transitioning to Stagflation

Global Asset Management’s Q2 2026 outlook suggests a shift from a period of monetary easing to a stagflation-like regime.

• Key Indicators: Investors are advised to look past geopolitical headlines and focus on robust earnings and macroeconomic data.
• The Shift: The economy is moving away from "reflation" (high growth/high inflation) toward a backdrop where downside risks to growth are becoming more observable while inflation risks remain to the upside.
• The Correlation Problem: Kevin Ray notes that in stagflationary environments, the correlation between equities and fixed income increases. This is problematic because fixed income loses its role as a "ballast" or hedge when both asset classes return negative results.

2. Earnings and Valuation

• Resiliency: US earnings have shown an 82% beat rate, which has helped alleviate valuation concerns held at the start of the year.
• Financial Sector Health: US banks show strong loan growth, and there is currently no evidence of systemic risk regarding private credit exposure within the US banking system.
• Geopolitical Impact: The duration of supply chain disruptions (e.g., potential closures or traffic curtailment in the Strait of Hormuz) is a critical variable. Prolonged disruptions act as a "mini supply shock," impacting energy and food prices, which in turn threatens consumption—a vital growth variable for the US and Canada.

3. Portfolio Construction Strategy

Global Asset Management is currently employing the following tactical allocation:

• Equities: Neutral to slightly overweight, with a defensive tilt. Focus is placed on Healthcare and Staples for value, paired with Materials to capture upside from underlying commodity exposure.
• Fixed Income: Underweight. Due to persistent inflation risks, bonds are viewed as less effective in the current climate.
• Alternatives: Overweight. Commodities and long-term infrastructure plays are identified as the primary sources of diversification for a balanced portfolio.

4. Monetary Policy and Currency Outlook

• Bank of Canada (BoC): Contrary to market expectations of a 25-basis-point hike, Global Asset Management expects the BoC to keep rates unchanged through 2026. They argue that economic slack in Canada will drive price pressures down, making a hike unnecessary. This outlook supports a bearish view on the Canadian dollar.
• Federal Reserve (Fed): The firm views the current market pricing of 11 basis points of cuts by year-end as "fair." Ray suggests the Fed may not need to cut rates at all, noting that the US labor market remains resilient and inflation risks are skewed to the upside.

5. Synthesis and Conclusion

The primary takeaway is that investors must prepare for a regime where traditional diversification (stocks/bonds) may fail. The "new normal" involves monitoring supply-side shocks that threaten to keep inflation elevated while growth slows. By shifting toward defensive equities, increasing exposure to commodities and infrastructure, and maintaining a cautious stance on fixed income, investors can better navigate the transition toward a stagflationary environment. The resilience of corporate earnings and the stability of the US banking sector provide a temporary buffer, but geopolitical volatility remains the most significant wildcard for the remainder of 2026.