Conflict, energy and markets: charting a course for investors

Investors face many uncertainties around the Middle East conflict, as it tests a world deeply dependent on energy.

A higher oil price over the next six months will create challenges for the global economy and for central banks.

But major economies enter this shock in a position of strength. Growth is stable, policy support is in place, and robust private sectors benefit from AI capex. This gives the world economy some cushion.

Major economies enter this shock in a position of strength

We expect a short-lived conflict given the costs involved for all the major powers. Of course, we stay alive to risks: a long war and much higher oil prices would raise inflation and unemployment, and lower growth.

But today’s backdrop is in stark contrast to the energy shock of 2022, when economies grappled with tight labour markets, rapid wage growth and tightening monetary policy. With cooler job markets and lower inflation, ex-energy, now in place, central banks have fewer reasons to raise rates.

In the US, any growth and inflation pressures are also a political concern as the Trump administration wants to avoid an affordability crisis ahead of November’s mid-term elections. Europe’s economic momentum should remain stable. Despite Europe’s energy vulnerability, supplies are also more diversified than four years ago. In emerging markets, structural trends look solid, although Asia’s economies are sensitive to higher energy prices. In China, recent economic policy offers limited new fiscal support, but this leaves room to respond to shocks.

Read also: Assessing the impact of US-Iran tensions for investors

Beyond energy, we keep an eye on US tariffs, which are still weighing on global growth. And AI will be transformative as its productivity gains boost growth, offsetting the drag from ageing populations, with limited unemployment impacts.

We have lowered portfolios’ risk exposure through short-term volatility

Conflict and disruptions are creating challenges for investors, with natural reactions in market sentiment. We have lowered portfolios’ risk exposure through short-term volatility, and stay invested and alert to opportunities as visibility improves.

Market volatility mostly reflects uncertain oil prices and rising inflation expectations. But stable economic growth and corporate fundamentals, supportive monetary and fiscal policies, mean stocks can outperform bonds this year.

Within equities, our overall exposure is now neutral. We have raised US equities to neutral because valuations have improved, with a strong earnings outlook. In sectors, we prefer technology, utilities and healthcare. Both the US market, and the tech stocks that dominate it, have been more shielded from the current conflict.

Read also: US-Israel-Iran conflict: macroeconomic and investment scenarios

In fixed income, we underweight global government bonds. We stay overweight in emerging market hard currency bonds, which still offer attractive yields.

In currencies, the dollar’s strength should remain temporary, and weakness to resume once the Fed cuts rates and overvaluation normalises.

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We have raised our 12-month Brent crude oil price target to USD 75. We keep our overweight exposure to gold. A stronger dollar and higher US interest rates make some short-term volatility inevitable. But we continue to see value in gold as a portfolio diversifier and risk hedge, and structural support for prices from rising demand.

There are many complexities ahead for markets. While geopolitical shocks are unsettling, the underlying climate remains favourable for risk assets. Diversification and discipline are the best responses to market turmoil.