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 energy security threat in history, with its scale even surpassing the sum of the two oil shocks in the 1970s. IEA Executive Director Fatih Birol stated this month that the amount of lost oil supply exceeds the sum of the two shocks in the 1970s, and the amount of interrupted natural gas supply is double the amount that Europe lost after the 2022 Russia-Ukraine conflict. At the same time, Trump's continued pressure on the independence of the Federal Reserve, similar to Nixon's pressure on then-Fed Chairman Arthur Burns, has further exacerbated concerns in the market about the ability of monetary policy to respond. Against this background, the policy statements of the Bank of England and the European Central Bank have noticeably become hawkish in the past two weeks, causing concerns in the market about whether policymakers will overreact, inadvertently triggering a recession while combating inflation. Analysts believe that if stagflation becomes a reality, both stocks and bonds will come under pressure. Lessons from history: Why supply shocks leave central banks in a dilemma Supply shocks have always been the most severe pressure test for central banks. After the 1973 Middle East war, the Arab members of OPEC reduced production, causing oil prices to quadruple and severely impacting the global economy. At that time, Federal Reserve Chairman Arthur Burns believed that the surge in oil prices was a non-monetary phenomenon and did not require a monetary policy response. The logic at that time was that price increases would correct themselves through supply elasticity and substitution effects, without the need for intervention. However, this logic overlooked the "second-round effects" of supply shocks, as workers demanded higher wages to offset the rising costs of energy and related commodities, and companies subsequently passed on the costs of energy and labor to consumers, leading to expectations of inflation becoming unanchored, and a spiral of wages and prices followed. In addition, the political pressure on Burns cannot be ignored. President Nixon and his Treasury Secretary John Connally pressured Burns through leaks to the media, eventually making him a compliant supporter of the government, maintaining interest rates at overly low levels, leading to an overheated economy. This is similar to Trump pressuring Fed Chairman Powell today. As a result, in the 1970s, inflation spiraled out of control in most countries, and by 1974, the inflation rate in the United States had entered the double-digit range, leading to economic stagnation. The Volcker moment, the lesson of tightness and the historical lesson of asset markets The out-of-control inflation was fundamentally reversed only after Jimmy Carter appointed Paul Volcker as Chairman of the Federal Reserve in 1979. Volcker implemented aggressive rate hikes to combat inflation, leading to a severe global recession, but also giving rise to the biggest bond bull market in decades. Under Volcker's leadership, the inflationary impact of the second oil crisis in 1979 was relatively limited. The experience in the UK was even more dire. The credit expansion policy of the Heath government at that time triggered a real estate and commercial property frenzy, with the retail price index reaching nearly 27% at its peak in 1975. When the bubble burst, the British government was forced to cede fiscal policy leadership to the International Monetary Fund. The yield on gilts soared into double digits, bond prices collapsed, and elderly investors relying on fixed-interest government bonds for retirement were heavily affected. The UK stock market experienced its most devastating bear market since the war: on December 13, 1974, the FTSE All-Share Index hit a historic low, with a peak-to-trough decline of 72.9% and a price-earnings ratio plummeting to a ridiculous 3.6 times. This historical period serves as a warning for the current private credit market, as analysts believe that politicians in both the United States and the UK are trying to attract retail investors into the rapidly expanding private credit market, similar to the aggressive expansion of the shadow banking system in the 1970s. Today's differences: Decreased energy dependency, but new risks have emerged Compared to the 1970s, there are several structural differences in the current situation. The energy intensity of developed economies has significantly decreased, and their dependence on oil-producing countries has markedly diminished. The policy reforms of Reagan and Thatcher in the 1980s fundamentally weakened labor negotiation power, raising the threshold for triggering wage spirals. Furthermore, more central banks in developed countries have gained varying degrees of independence. However, the lessons of uncontrollable inflation from 2021 to 2022 indicate that these structural advantages are not enough to provide a worry-free environment. Economist Hyman Minsky had long pointed out that long-term economic stability often breeds excessive complacency among policymakers, businesses, and households. It was only after more than a decade of low inflation following the great financial crisis that central banks brought out Burns' script again when faced with inflation pressure in 2021-2022, categorizing supply-side inflation as a "temporary" phenomenon, resulting in another misjudgment. Another potential danger today comes from public debt. Public debt levels during peacetime have reached unprecedented levels, and in some countries, including the United States, public debt interest payments have exceeded defense spending. In low-growth economies, pension and healthcare expenditures are inflating while tax resistance exists, creating a risk of debt monetization. Yet, the market does not seem to have fully priced in this risk. Asset allocation, diversification is the primary principle for addressing multiple risks In a stagflationary environment, bonds and stocks have historically come under pressure simultaneously, rendering the traditional asset allocation logic ineffective. Gold, as a geopolitical hedge, surged by 65% by 2025 and is now at a high, but its rapid decline in the past three weeks indicates that it is not a stable safe haven in times of falling other assets. Bitcoin, lacking intrinsic value, has fallen by over 40% in the past six months. According to the latest edition of the "Credit Suisse Global Investment Returns Yearbook," Elroy Dimson, Paul Marsh, and Mike Staunton point out that a portfolio of commodity futures has excellent inflation hedge properties and outstanding long-term performance, but lags in long-term deflationary cycles. For ordinary investors, stocks that generate stable cash flow may be more practical. Dimson and others point out that although such stocks have limited correlation with inflation, they can outperform inflation in the long run with equity risk premium. Faced with the rare combination of geopolitical, inflation, and recession risks today, analysts emphasize that diversification of allocation is the most important principle for addressing these risks, including the allocation of cash. Even in the current high inflation environment, cash is providing positive real returns once again. This article is selected from "Wall Street See", authored by Yi Long Bao; GMTEight editor: Yu Cheng He.