It’s been a busy week in financial markets. We wouldn’t normally talk much about such a short time period, but given the ongoing conflict in the Middle East, we wanted to understand how financial markets have reacted and what we think that means. We continue to hope for a swift and peaceful resolution to the current conflict.
Looking at the past week, we think there are a few points to make.
First, markets generally behaved as we might have guessed. Commodities were stronger, thanks to rising oil prices, while equities weakened. Longer-dated bonds suffered a bit more than shorter-dated bonds, as concerns about inflation prompted bond yields to rise.
Second, the overall market reaction seemed fairly constrained – given the potential for further disruption to global energy supply. We think that financial market investors in aggregate are so far taking a fairly optimistic view – that the conflict will prove relatively short-lived and the impact on the global macro environment will be quite limited.
Then, within equities, the US fared relatively well. We think there are a few reasons for that. There’s the distance – the US is far removed from the centre of the conflict.
The US is also largely self-sufficient in energy, even if higher oil prices will still hit US gasoline prices. And we’ve also seen the dollar strengthen this week, as investors look for safe havens. That’s helped the return of US equity ETFs denominated in sterling or euros.
On the weaker side, European and Emerging Market equities were relatively weaker. We think this reflects concerns that higher energy prices and supply disruption in the Strait of Hormuz could hit Europe and Asia harder than the US.
Finally, within the credit space, we’ve seen that riskier exposures, like global high yield or Emerging Market debt have so far held up pretty well – in some cases reflecting their shorter duration. So far, investors don’t seem very worried about weakening credit quality as a result of the conflict.
What does it all mean for portfolios? We should be wary of drawing too many conclusions from only a few days. That said, we think markets have so far held up better than we might have feared. Diversification clearly helped – with commodities, the US and corporate credit being particularly useful. Longer-dated government bonds were less helpful in diversifying equity risk, and it’s a reminder that diversification doesn’t just mean equities and government bonds. For now, we continue to debate a range of scenarios and we’ll make changes to portfolios if we see the need or the opportunity.
*As with all investing, financial instruments involve inherent risks, including loss of capital, market fluctuations and liquidity risk. Past performance is no guarantee of future results. It is important to consider your risk tolerance and investment objectives before proceeding.
