Why fixed income and cash lose their defensive edge in FY27

Advisers heading into this reporting season are dealing with a combination that does not come along often. Inflation is still elevated, unemployment is rising, growth is slowing, the Reserve Bank of Australia (RBA) is hiking into that slowdown, and new tax measures are landing in the same financial year.

None of those alone is unusual. Together, they change what a resilient stagflation investment strategy looks like.

The stagflation light thesis

Emanuel Datt, chief investment officer at Melbourne-based Datt Capital, has a name for the combination: “stagflation light”. Energy constraints and supply price shocks are compounding the pressure. It is not the full 1970s scenario, but it is enough to break the assumptions still underpinning most portfolios.

“Low growth and high inflation is not an environment that rewards broad index exposure. It rewards selectivity, cash flow certainty, and assets with pricing power.”

His view is that fixed income and cash carry a structural disadvantage over the medium term in this setting. That cuts against the standard defensive playbook advisers have leaned on since rates started falling from their peak.

Why energy is doing the heavy lifting on inflation

It is a strong call against duration, and the mechanics behind it are specific. On the energy side, the Strait of Hormuz situation is constraining global oil supply. That is pushing fuel and headline inflation higher.

The market prices domestic gas off the LNG netback rate to Asia, so Australian electricity costs stay firm regardless of what happens locally. There is no new domestic oil and gas development policy in the pipeline to ease that pressure, either.

Qatar’s reduced market access and below-average gas storage across Europe and Asia mean both regions are competing for the same tight supply. Thermal coal is picking up demand as a substitution fuel.

Commodity demand more broadly is proving resilient even as growth slows. Copper is riding the AI data centre build-out and the broader electrification trend. Geopolitical uncertainty and currency debasement pressure are keeping gold demand firm. Continued urbanisation across Asia is underpinning iron ore and steel-adjacent minerals.

The inflation side of stagflation light has real structural drivers behind it, not just base effects.

The case for small caps

The small-cap side of the thesis is where valuation dispersion is doing the work. Small-cap valuations had been converging with large caps through late 2025, according to Datt. Geopolitical disruption from March 2026 then pushed the discount back out to around 20 per cent.

Add AI productivity tailwinds and scope for cost-out, and that discount can produce an outsized earnings swing relative to what investors are paying, if the underlying businesses have the fundamentals to back it up.

Strip away the ticker codes and the whole approach comes down to one distinction. Datt keeps coming back to it: what a company earns today against what it might earn someday.

“Our clear bias for FY2027 is owning cash flow, not hope. We want exposure to companies that are resilient and well-priced, where we can benefit from the economics in the present, not in a speculative future.”

A stagflation investment strategy for FY27

Where this leaves portfolio construction is less about picking a theme and more about applying a filter. Datt Capital’s own positioning runs across three categories.

The first is energy exposure through coal names geared to seaborne thermal coal pricing. The second is growth franchises trading at a discount to 52-week highs with intact structural tailwinds. The third is what Datt calls strategic assets: scarce, hard-to-replicate businesses in software and strategic metals whose value compounds over time.

The specific names are Datt Capital’s calls, not a template. But the filter behind them, cash flow quality over index weight, is transferable to any adviser reviewing client portfolios ahead of FY27.

The allocation conversation this environment demands

Advisers who have not yet stress-tested client portfolios against this environment should. In a market with narrow breadth and concentrated sector leadership, where advisers allocate capital is starting to matter more than how much they allocate.

A sound stagflation investment strategy starts with one question for every holding: does this company earn real money today, or is the investment case built on earnings that have not arrived yet?

In a stagflation light environment, that second category faces a double headwind. Higher rates compress the value of future cash flows, and slower growth means those futures take longer to materialise.

Datt’s three filters, energy with pricing power, growth at a discount, and strategic assets that compound, each ask the same thing: what is this worth if growth disappoints and inflation stays?

That is a harder conversation than “stay the course”, but it is the one this environment is asking for.