Quarterly market update: Investment opportunities emerge amid geopolitical volatility

We were active during the quarter as market volatility created opportunities to add to equities at more attractive valuations. The sharp sell-off at the outset of the Iran war led to a broad pullback in equity markets and particularly in regions with higher sensitivity to oil imports. Historically, equities tend to recover from geopolitical shocks, particularly when corporate earnings remain resilient.

Our response:

The Iran-US conflict has severely impacted energy markets, with around 12% of global oil supply disrupted. However, several important factors give us confidence that the broader economic backdrop remains robust. First, the oil market entered the conflict in a relatively oversupplied position, which helped cushion the impact of supply disruptions. At the same time, underlying fundamentals remain supportive. Economic growth momentum is solid, household balance sheets are strong, and corporate profitability continues to support hiring and capital investment.

While we do remain concerned that the Strait of Hormuz remains closed and energy is in short supply, we think in among the bluster both countries have maintained the ceasefire and that the more likely path is for compromise to be reached and for the Strait to be opened. Markets are forward looking and, despite current supply pressures, are increasingly discounting a normalisation in supply.

Against this backdrop we increased our overweight to equities, particularly to Emerging Markets. These markets initially sold off more sharply, partly because many countries have a high reliance on energy imports. We viewed this reaction as excessive, as Emerging Markets play a crucial role in the global AI supply chain, with their leading role in semiconductor manufacturing and advanced hardware, positioning them well to benefit from longer-term earnings growth driven by artificial intelligence. This combination of short term dislocation and attractive long term growth potential led us to selectively add exposure at more compelling entry points.

We see the risks stemming from higher oil prices more pronounced for bond markets than for equities. Elevated energy prices can reinforce longer-term inflation pressures, which tend to weigh on bond returns, particularly through higher interest rates. However, we believe current market expectations for central bank rate hikes are excessive, particularly as pockets of economic weakness are becoming more evident.

Our response:

During the quarter, concerns around persistently higher inflation, impacted by rising oil prices, led us to reduce exposure to both government and corporate bonds. Corporate bonds continue to trade at historically tight spreads – meaning investors are receiving limited additional compensation for taking on credit risk – making them less attractive relative to equities at current levels.

That said, we expect fragile growth in certain economies to ultimately limit how far central banks can continue tightening policy. This is especially relevant for the Bank of England, where the economic outlook remains challenging and growth momentum is weak. In our view, markets have placed too much emphasis on the inflationary impact of the oil shock while under-pricing the risk of slower growth if the Strait of Hormuz remains closed.

As a result, we adjusted our bond positioning by shifting some of our longer duration exposure from US government bonds to UK government bonds. We believe UK bonds have sold off far too much relative to developed market peers and offer attractive yields if interest rate hike expectations are scaled back.

Despite a large geopolitical shock, the dollar’s rise has been noticeably more modest than would typically be expected in a risk-off environment. This reinforces our view that the US dollar remains in a structural bear market.

Our response:

We remain negative on the US dollar and confident in maintaining an underweight exposure. However, this currency view is separate from our assessment of the US economy, which we continue to see favourably. The US is relatively insulated from the oil shock compared with other regions, and the productivity boost from artificial intelligence adoption remains a meaningful tailwind for growth.

Given this backdrop, we reallocated capital from European equities – our largest regional overweight – into US equities via the S&P 500, while hedging the currency exposure back into euros. This allowed us to gain increased exposure to the strength of the US economy and its earnings potential, without taking on additional US dollar risk. While we remain constructive on Europe’s fiscal spending plans – particularly in Germany – Europe is more vulnerable to increases in energy prices.

A key differentiator of our portfolios is access to alternative investments, which help diversify risk. While we remain confident in the broader economic backdrop, we recognise the risks associated with persistently higher oil prices. Even if the Strait of Hormuz were to reopen quickly, oil production would take time to fully ramp up and prices may stay elevated.

Our response:

To help manage the risk of higher oil prices, we initiated a structured product linked to the oil price. The investment pays a 10% coupon over the year, provided oil prices remain above $47, offering a hedge in scenarios where energy prices stay elevated. As noted above, we do not expect oil prices to return to pre war levels in the near term, even if supply routes were to normalise. Looking at history, oil prices have traded below $47 only around 10% of the time over the past 20 years, which reinforces the attractiveness of this structure as both a defensive and diversifying addition to the portfolio.

Our outlook for artificial intelligence (AI) remains positive, as large technology companies continue to significantly ramp up capital expenditure to stay ahead in the AI buildout. Early indications from the Q1 earnings season reinforce this view, with ‘hyperscalers’ consistently highlighting that semiconductor supply –  especially in the memory segment of the market – remains constrained and well below current demand, suggesting the AI investment cycle is still at an early stage.

Our response:

We increased our allocation to semiconductors, which are the most direct beneficiaries of rising AI-related spending. Demand for advanced chips and memory remains robust as investment in data centres and computing infrastructure accelerates, positioning the sector well for continued earnings growth.

In the meantime, we remain overweight to the Magnificent Seven companies, which exhibit strong fundamentals and are at the forefront of AI development and deployment.