The magnitude and duration of this oil shock remain difficult to quantify, and the impacts on markets are more uncertain – given the implication for global inflation and central-bank response functions. At the time of writing, markets had begun pricing in potential for Federal Reserve (Fed) interest-rate hikes and projected two for Europe’s central bank this year, amid reports of constructive US-Iran negotiations. In this fluid environment, we are digesting newsflow and remain focused on the more solid dynamics of hedging levels versus divestment across markets, and the resilience of corporate earnings.
Read also: Iran oil shock: how could the US, Europe and Asia be impacted?
Seeking growth and inflation signals amid the noise
This crisis challenges the investment world from multiple angles. First, the duration of the conflict is difficult to predict and is surrounded by heavy noise. Second, paralysis in the Strait of Hormuz creates a dual threat: scarcity of supply for countries most exposed to energy commodities while simultaneously triggering inflationary forces that could harm global demand. With upcoming leadership transitions at both the Fed and European Central Bank, interest-rate risk is also on the rise.
The resilience of corporate profits also remains uncertain, especially since most analysts still view this shock as temporary. Growth projections among the G20 economies have remained surprisingly stable (see Figure 1). However, the potential impact on demand appears to be a significant blind spot for markets – and this uncertainty makes this situation particularly complex.
FIG 1. G20 economic consensus since the Iran war began (left) and changes in US 10-year yields (right)1
Are investors hedging or selling?
What investor behaviour differentiates a transitory shock from a long-term disruption? Temporary volatility calls for hedging strategies in order to maintain stability without liquidating cash assets – which can be difficult to repurchase once risk subsides. A sustained shock leads investors to unwind these protective positions as they restructure underlying asset-class exposures.
So far, derivatives trading has been significantly greater than other investment activity, indicating that investors in general currently favour temporary protection over asset reallocation, and their response has been less severe than in previous energy shocks (see Figure 2). In the coming weeks, comparing transaction volumes between derivatives and physical markets will be a critical indicator to understand how markets are gauging the potential duration of the crisis.
FIG 2. Energy-shock reactions: S&P 500 drawdowns vs the VIX (left) and cash vs CDS spreads2
Read also: Positioning net-zero equities for resilience in crisis, strength in transition
In equity markets, earnings progression has taken over from multiple expansion
Rising stock prices typically advance through two drivers: earnings progression, when economic strength translates directly into higher corporate profits; or multiple expansion, as investors show greater willingness to pay greater valuations for those earnings.
Multiple expansion has driven equity-market momentum over the past three years. This typically occurs as interest rates normalise following a shock – last time, this was the energy disruption and steep monetary-policy hiking cycle of 2022. However, now that rates have at least stabilised amid the current geopolitical disruption, earnings growth must take the wheel as the primary driver in order to underpin equity performance. Figure 3 shows that consensus estimates project robust earnings growth exceeding 10% annually for several years. With multiple expansion likely to ease, continued earnings momentum should provide markets with sufficient fundamental support to weather the present shock.
FIG 3. Global equities: earnings growth projections3
Our positioning across asset classes4
Our long-only investment teams remain vigilant amid this latest shock, monitoring the situation closely to adapt portfolios.
Multi asset. The All Roads team has reduced overall market exposure to 145%, with a higher allocation to defensive assets, at 65%, versus cyclical, at 35% (rebased to 100%).
Fixed income. Our Global Fixed Income team remains neutral, with an underweight to sovereigns, favouring Treasury Inflation-Protected Securities (TIPS) over nominal US Treasuries, and an overweight to emerging-market (EM) hard-currency debt. Within credit, exposure to investment grade and high yield (HY) is neutral, with a selective tilt. Our Asia Fixed Income team maintains a preference for defensive HY and remains overweight India, commodities, subordinated financials and emerging market HY sovereigns.
Convertible bonds. The team remains overweight the US, but has reduced the Asia-ex Japan exposure. While maintaining a constructive stance, the global strategy portfolio holds a barbell allocation between defensives and AI beneficiaries and favours semiconductors and defence versus airlines and property. The cash position has also been raised.
Equities. Our Global Equities team is repositioning its portfolio by reducing its large underweight US position at the expense of Asia. In terms of sectors, it has extended the overweight to consumer staples but lowered exposure to consumer discretionary, communications services and IT. The Sustainable Equities team favours emerging markets over the US, retaining exposure to AI capex beneficiaries, rising demand for power in Europe, and transition materials. Our Swiss Equities team has lowered overall market exposure, but remains overweight consumer staples, healthcare, information technology and industrials, and underweight communication services, consumer discretionary, financials, real estate and utilities. The Asia Equities team favours technology, diversified industrials and consumer discretionary stocks over financials, consumer staples, utilities and healthcare.
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