Middle East unrest and its influence on markets

Subsiding tensions for now 

Unsurprisingly, tensions spiked higher following the flashpoint with Israel’s expanded ground operation into Rafah. However, with limited international reaction, the potential for a broader regional escalation subsided. Unfortunately, however, we know that circumstances can change rapidly.

Geopolitical risk is complicated

We are entering a heightened phase of uncertainty and likely volatility for markets. Geopolitical risk can impact the global economy and supply chains in a number of ways. These are some scenarios we could see:

Sustained Oil price rises

As we have seen from the Russia-Ukraine conflict, the most immediate impact of a broader and escalatory conflict is likely to be oil prices moving higher (and crucially staying high), which could quickly transmit globally across financial markets.

Sticky inflation

If oil prices were to rise longer term, it would also come when there is already concern about sticky inflationary pressures. In the US, for example, this could diminish hopes for central bank rate cuts.

Disappearing soft landing

However, geopolitical risk is complicated and multi-faceted. If the risk to economic growth proves too great, then fears of a slowdown could prompt central banks to pre-emptively loosen policy, which can have both positive and negative impacts.

Our asset allocation views are nuanced

Despite our overall constructive outlook, we are mindful that tail risks continue to exist. So, we are keeping our exposure balanced towards more than one economic scenario:

Macro

We believe we are continuing down a track for a ‘goldilocks’ global economy. In this scenario, inflation continues downward without growth stalling. Despite the hyper-focus from markets on short-term movements - which we should be aware of the medium- to the longer-term direction of travel for inflation has been mostly downward.

Equities

We continue to advocate a global balance between equity value and growth investment styles. Specifically, within growth sectors, we have a positive outlook on the US as corporate fundamentals remain strong. We believe there is scope for small- and mid-sized companies in the US to outperform their larger counterparts as the year progresses and the leadership by sector has broadened.

Fixed income

Given the near-term risks of inflation remaining sticky, we have slightly increased exposure to government-issued inflation-linked bonds. We believe this will reduce portfolio sensitivity to inflation surprises, improve risk-adjusted returns (by providing a yield similar to traditional bonds but with lower volatility), and provide more targeted exposure to higher inflation expectations.

Our key takeaways

By remaining focused on your long-term investment objectives, you will have greater potential to weather short-term market volatility and capitalise on the growth potential of your investments. It is important to remember that staying invested in a well-diversified portfolio gives the greatest potential for your investment portfolio to grow.

It is understandable that investors become apprehensive during shorter-term market volatility and will instinctively want to exit the markets and move to cash. This can be counterintuitive as only by disinvesting are you realising the loss or lower value of your investments. By remaining invested, you give your investments time to recover when the volatility subsides without incurring any ‘real’ losses. 

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