Geopolitics and markets staying focused on the long term

The conflict in the Middle East continues. After another noisy week, we wanted to take stock of where we are. 

The outlook remains quite unclear. The US administration appears keen to move forward with negotiations to reopen the Strait of Hormuz, while at the same time increasing its troops in the region. Iranian leadership seems happy to deny its negotiating at all, while allowing an increasing number of “non-hostile” tankers to leave the Straits. Israel continues to fight on several fronts, against both Iran and in Lebanon. Finally, the war in Ukraine also continues with a potential impact on global energy supply. 

If we look at current prices, we think investors continue to look for a relatively swift resolution to the conflict – at least as regards the supply of energy, even if the latest version of the conflict has already extended longer than we might have hoped. Global equities are down around 6.7% (in sterling) since the end of February. We think this reflects the potential damage to expectations for growth and earnings from the past few weeks, rather than expectations of a more protracted conflict.

Digging into the details a bit more, we think investors see a rising risk of stagflation – slower growth and higher inflation. That’s meant that equities and long-dated bonds have both suffered as oil prices have risen, with long-dated gilts slightly underperforming UK equities so far this month. It’s a reminder that diversification isn’t just about allocating between government bonds and equities. But government bond duration isn’t the only challenge when it comes to constructing a portfolio. 

The sell-off in gold has also been notable. Under “normal” circumstances, you might have argued that gold would be a useful safe haven during a geopolitical crisis, but gold has underperformed both bonds and equities so far this month. We think this partly reflects some profit-taking after its strong performance over the past year and the impact of potentially higher real interest rates going forward. 

So where does that leave us? The geopolitical environment remains uncertain. There’s lots of commentary available but possibly limited insight. There is clearly pressure building to find an “off-ramp”, a way to de-escalate the conflict and help bring down oil prices. And that’s what we expect to see in due course. But it’s tough to know how long that process will take. The longer the conflict continues, the greater the impact on the global economy. 

In terms of our current positioning, we think portfolios remain well-diversified and fairly conservative, albeit in an environment where both bonds and equities have suffered. We don’t think equities have yet fallen far enough for us to add. Headline valuations are getting cheaper, and that should be positive for long-term returns, but the impact on earnings forecasts is possibly still to come. On the fixed income side, we think that longer-dated bonds are beginning to look more attractive, despite their volatility, and we don’t own much of them in our portfolios currently. 

While we look for ways to protect and enhance our portfolios, we think it’s important that clients focus on their long-term goals, rather than short-term noise, particularly during these periods of market volatility.