The growing conflict between US and Iran has abruptly shifted the market's focus from artificial intelligence to the stark realities of geopolitical conflict and potential oil disruptions.
While the initial market reaction was contained, a growing sense of risk aversion is taking hold as investors begin to price in medium-term uncertainties.
For investors, navigating this “fog of war” requires a clear understanding of the immediate risks, the drivers of market responses, and the underlying long-term trends that persist.
Structural trends remain
The most significant risk to the global economy is the potential for an extended stalemate in the Strait of Hormuz. The conflict threatens the security of oil and goods flows through this critical channel.
Markets are now pricing in the probability that the US and its allies might fail to secure the strait, a scenario exacerbated by Iran's potential to enforce a “quasi-closure” using drone technology.
The situation remains highly fluid, and investors continue to price in several fundamental scenarios alongside the evolving news flow.
Overall, when it comes to investment implications, we see the outcome as binary: either the conflict is (relatively) swift and “victory” is at least presented as decisive, not unlike the previous Iran conflict in June last year, or the war drags on and oil prices remain elevated for a prolonged period of time, weighing heavily on global economic activity.
Besides the unsurprising rise in oil prices, markets have hardly moved, which is noteworthy considering the high level of uncertainty surrounding the duration and outcome of the war.
Except the US dollar, everything is more or less in the red, with positioning determining the extent of de-rating rather than any fundamental considerations.
Gold is a case in point. In theory, gold should benefit from the increase in geopolitical risk, but it has instead been influenced by profit-taking after its successful run following January’s precious metals flash crash. The same behaviour could be observed in strategic metals like copper.
The rise in the USD may have surprised some, but given the universally bearish positioning in the greenback in recent times, the threshold for it to re-rate and fulfil its traditional safe-haven role in such circumstances was not high.
Overall, the structural trends at work before the Iran war started have not changed. The world economy is resilient and was actually poised to accelerate across all regions going into the second quarter. Corporate profits are strong, with big AI capital expenditures the main and only unknown in this respect.
Investors were rebalancing away from intangible business models into tangibles ones, a trend that favours non-US markets. China’s balance sheet recession will heal better and faster if household balance sheets are reflated by an equity bull market.
G7 fiat currencies are all dubious stores of value in a global context of fiscal dominance. The latter is unlikely to go into reverse with this new war and more generally, we would argue that the prevailing trends have only been strengthened by the current conflict.
Oil trade disruptions merely reinforce the need to secure resilient supply chains and to build ample reserves of strategic resources for national security purposes. While gold may be in a multi‑month consolidation phase, the US’ proactive refocusing towards its sphere of influence will only spur non‑western economies – including China, which needs to recycle record current account surpluses into investments – to further diversify away from US assets, providing the yellow metal with structural support for years to come.
Near-term: exercise caution
The immediate future is clouded with uncertainty. The unpredictable nature of the conflict and the potential for severe economic disruption means that this is a time for caution, not aggressive bargain-hunting.
The extent, both in price and duration, of the current increase in risk is a function of how long the current uncertainty persists.
Long-term: look for opportunity
So far, the market has not given rise to an exceptional buying opportunity, as would usually be the case in the context of an external shock. However, the unwinding of excessive positioning caused by the war could allow investors to rebalance their portfolios in line with prevailing trends. The key recommendations are:
- Rebalance away from the US: Continue the trend of global diversification away from US assets and technology stocks.
- Favour tangible models: Shift focus from intangible business models to tangible ones. This trend favours non-US markets, precious metals, and emerging markets.
- Diversify currencies: The fiscal dominance in G7 countries makes their fiat currencies dubious long-term stores of value. Investors should consider diversifying into precious metals, the Swiss franc, the Singapore dollar, and select emerging market currencies.
While the near-term calls for a defensive posture, the current crisis provides a moment of clarity for long-term investors.
It serves as a catalyst to rebalance portfolios and strategically position for the enduring structural shifts in the global economy.
Yves Bonzon is group chief investment officer of Julius Baer
