Strategic Asset Allocation in a High-Policy-Uncertainty World: Leveraging Non-US Equities and Inflation-Protected Assets to Hedge Stagflation

In 2025, the global economic landscape is defined by a perfect storm of policy uncertainty, trade tensions, and inflationary pressures. The Global Economic Policy Uncertainty Index has reached its highest level since the early 2000s, driven by escalating tariffs, geopolitical fragmentation, and divergent monetary policies. Against this backdrop, stagflation—a combination of high inflation and stagnant growth—looms as a significant risk. Investors must adapt their asset allocation strategies to navigate these challenges, prioritizing diversification and inflation resilience. This article examines how non-US equities and inflation-protected assets can serve as critical tools in this effort.

The Case for Non-US Equities in a Stagflationary Environment

Non-US equities have outperformed their US counterparts by a staggering 11% year-to-date in 2025, marking a historic reversal from the dominance of US markets in the previous decade. This shift is driven by three key factors: valuation discounts, a weaker US dollar, and structural reforms in key economies.

1. Attractive Valuations: The MSCI ACWI ex USA Index trades at a forward P/E ratio of 13.4x, compared to the S&P 500's 20.9x. International equities are currently at the 8th percentile of their historical relative valuation, a level last seen during the 2008 financial crisis. This discount is broad-based, with over half of global sectors trading below their 20-year median P/E.
2. Dollar Weakness: The US dollar has depreciated by 11% year-to-date in 2025, enhancing the USD value of returns from non-US markets. This trend is supported by global central banks' de-dollarization efforts, including increased gold purchases and diversification of foreign exchange reserves.
3. Structural Reforms and Fiscal Stimulus: Europe, in particular, has emerged as a bright spot. Germany's $546 billion infrastructure fund and relaxed borrowing rules for defense spending have boosted investor confidence. Similarly, China's moderation of growth (from 5.0% in 2024 to 4.7% in 2025) has stabilized trade flows, reducing downside risks for emerging markets.

Investors should consider overweighting defensive sectors such as healthcare, utilities, and infrastructure in non-US markets. These sectors have historically outperformed during stagflation, as seen in the 35% year-to-date gain in European defense stocks. However, active management is crucial to mitigate idiosyncratic risks, such as regulatory shifts in pharmaceuticals or trade barriers in critical industries.

Inflation-Protected Assets: TIPS and Real Assets in a High-Inflation World

While non-US equities offer growth potential, inflation-protected assets remain essential for preserving capital. Treasury Inflation-Protected Securities (TIPS) and real assets like real estate and infrastructure are often cited as hedges, but their effectiveness in 2025 is nuanced.

1. TIPS: A Short-Term Hedge with Caveats:
   TIPS provide a real rate of return by adjusting principal for inflation, making them a natural choice for stagflationary environments. However, their performance in 2025 has been volatile due to supply/demand imbalances in the Treasury market and concerns over US fiscal sustainability. Short-term TIPS (maturities under 5 years) have shown more stability, with yields reflecting current inflation expectations. Investors should pair TIPS with currency-hedged positions to avoid dollar-related risks.

2. Real Assets: Operational Strategy Matters:
   Real assets, including real estate and infrastructure, offer inflation resilience but require careful selection. For example:

3. Real Estate: Properties with flexible leases and operating expense pass-through clauses can adjust rents to match inflation. However, assets with long-term fixed leases (e.g., industrial warehouses) may underperform.
4. Infrastructure: Assets with regulated utility structures or long-term contracts (e.g., toll roads) can pass cost increases to consumers, preserving equity value.
5. Gold and Commodities: Gold has surged to record levels in 2025, defying traditional correlations with bond yields. While it serves as a store of value, its speculative nature makes it a complementary, rather than core, hedge.

1. The Limits of Traditional Hedges:
   In 2025, the reliability of traditional safe-haven assets has waned. The US dollar, once a cornerstone of global portfolios, has weakened against the euro and yen. Similarly, long-duration Treasuries have faced volatility due to fiscal concerns. Investors must diversify across currencies and asset classes to avoid overreliance on any single instrument.

Strategic Recommendations for 2025 and Beyond

1. Diversify Across Geographies and Sectors: Allocate 40–50% of equity exposure to non-US markets, focusing on value-oriented sectors like healthcare and infrastructure. Use active management to identify companies with strong balance sheets and inflation-adjusted revenue streams.
2. Balance Inflation Hedges with Growth: Allocate 15–20% to TIPS and real assets, favoring short-duration TIPS and real estate with adjustable pricing mechanisms. Avoid overexposure to gold or commodities unless used as tactical allocations.
3. Monitor Policy Shifts: Stay attuned to trade policy developments, particularly in the US and China. A further escalation in tariffs could disrupt global supply chains and erode the appeal of non-US equities.
4. Revisit Currency Exposure: Consider hedging against the dollar by allocating to the euro, Swiss franc, or Japanese yen, which have shown resilience in 2025.

Conclusion

The stagflationary risks of 2025 demand a strategic rebalancing of portfolios. Non-US equities offer compelling valuations and diversification benefits, while TIPS and real assets provide inflation resilience. However, success hinges on active management, sector selection, and a willingness to adapt to evolving policy landscapes. By combining these elements, investors can build a resilient portfolio capable of weathering the uncertainties of the 21st century.