The lesson for investors from the last "oil shock"—the "1970s"

```

The current energy crisis has been characterized by the International Energy Agency as the most severe threat to energy security in history, surpassing the combined magnitude of the two oil shocks of the 1970s.

Fatih Birol, Director of the International Energy Agency, stated this month that the oil supply lost this time exceeds the total of the two shocks in the 1970s, and the cut-off of natural gas supply is twice the amount lost by Europe after the Russia-Ukraine conflict in 2022.

Meanwhile, Trump’s ongoing pressure on the Federal Reserve’s independence mirrors Nixon’s suppression of then-Fed chairman Arthur Burns. This has further intensified market concerns over the monetary policy's ability to respond effectively.

Against this backdrop, policy statements from the Bank of England and the European Central Bank have notably leaned hawkish in the past two weeks. The market is beginning to worry whether policymakers might overcorrect and inadvertently trigger a recession while fighting inflation. Analysts believe that if stagflation materializes, both stocks and bonds will be under simultaneous pressure.

Historical Lessons: Why Supply Shocks Put Central Banks in a Dilemma

Supply shocks have always been the most severe stress tests for central banks.

After the 1973 Middle East War, OPEC Arab member countries cut production, oil prices quadrupled, and the global economy was devastated. At that time, Fed Chairman Arthur Burns believed that the surge in oil prices was a non-monetary phenomenon and did not require a monetary policy response.

The Fed's logic at the time was that price increases would correct themselves through supply elasticity and substitution effects and there was no need for intervention.

However, this logic overlooked the "second-round effects" of supply shocks: workers demanded higher wages to offset rising energy and commodity costs, companies then passed energy and labor costs onto consumers, and inflation expectations became "unanchored," creating a wage and price spiral.

Moreover, the political pressure Burns endured was equally significant.

US President Nixon and his Treasury Secretary John Connally pressured Burns through media leaks, eventually making him a compliant supporter of the government, keeping interest rates too low and overheating the economy. This is very similar to the current pressure Trump is exerting on Fed Chairman Powell.

As a result, inflation spiraled out of control in most countries in the 1970s, and by 1974, US inflation had entered double-digit territory, plunging the economy into stagnation.

The Volcker Moment: The Cost of Tightening and Asset Market Lessons

Inflation did not fundamentally reverse until Jimmy Carter appointed Paul Volcker as Fed Chairman in 1979.

Volcker controlled inflation with aggressive rate hikes and a hard landing, at the cost of a harsh global recession. But this also triggered the biggest bond bull market in decades, and under Volcker’s leadership, the inflationary impact of the second oil crisis in 1979 was relatively limited.

Britain’s experience was even more brutal. The Heath Government's relaxed credit policies at the time fueled a frenzy in real estate and commercial property, with the Retail Price Index inflation approaching a peak of 27% in 1975.

When the bubble burst, the British government was forced to hand over fiscal policy control to the International Monetary Fund. Gilt yields soared into double digits, bond prices collapsed, and elderly investors dependent on fixed-rate government bonds were badly hit.

The UK stock market suffered the most brutal bear market since the war: on December 13, 1974, the FTSE All Share Index hit its all-time low, with a drop of 72.9% from its peak, and the price-to-earnings ratio fell to a ridiculous 3.6 times.

This history serves as a warning to today’s private credit markets. Analysts believe current US and UK politicians are trying to draw retail investors into the rapid expansion of private credit markets, which has several parallels with the aggressive expansion of the UK shadow banking system in the 1970s.

Today’s Differences: Lower Energy Dependency but New Risks Emerging

Compared to the 1970s, there are several structural differences today.

The energy intensity of developed economies has significantly decreased, and dependence on oil-producing countries has noticeably weakened. Policy reforms by Reagan and Thatcher in the 1980s fundamentally weakened labor bargaining power, raising the threshold for triggering wage spirals.

In addition, more central banks in developed countries have attained varying degrees of independence.

However, the lessons of runaway inflation from 2021 to 2022 show these structural advantages are not enough to permit complacency.

Economist Hyman Minsky pointed out long ago that prolonged economic stability often breeds over-confidence among policymakers, businesses, and households.

It was precisely in the prolonged low-inflation period after the global financial crisis that central banks again invoked Burns’s playbook when inflationary pressures re-emerged in 2021-2022, characterizing supply-side inflation as "transitory" and once again misjudged the situation.

Another major current danger comes from public debt. The level of public debt during peacetime is now unprecedented, and in countries including the US, payments on public debt interest have exceeded defense spending.

In low-growth economies, pension and healthcare expenditure are booming while resistance to tax increases persists, increasing the risk of debt monetization, a risk the market does not seem to have fully priced in yet.

Asset Allocation: Diversification as the Primary Principle for Facing Multiple Risks

In a stagflation environment, bonds and equities are traditionally under simultaneous pressure, invalidating conventional asset allocation logic.

Gold, as a tool for geopolitical hedging, has reached a high after cumulatively rising 65% in 2025, and its rapid drop over the past three weeks shows it is not a stable safe haven when other assets fall. Bitcoin, lacking intrinsic value, has dropped over 40% in the past six months.

According to the latest "UBS Global Investment Returns Yearbook," Elroy Dimson, Paul Marsh, and Mike Staunton, using a global market database dating back to 1900, point out that commodity futures portfolios have strong inflation-hedging qualities and outstanding long-term returns, but perform poorly in long-term deflation cycles.

For ordinary investors, stocks generating stable cash flows may be more practical. Dimson et al. point out these stocks have limited correlation with inflation, but can outperform inflation over the long run thanks to the equity risk premium.

Faced with an unprecedented confluence of geopolitical, inflation, and recession risks, analysts emphasize that diversified allocation is the most important principle, which includes keeping cash; even in today’s above-target inflation environment, cash has once again provided positive real returns.

Risk Warning and DisclaimerThe market involves risks; investment requires caution. This article does not constitute personal investment advice, nor does it take into account the specific investment goals, financial situation, or needs of individual users. Users should consider whether any opinion, viewpoint, or conclusion in this article is suitable for their particular situation. Invest accordingly at your own risk. ```