What recent tensions mean for markets

In our latest monthly update video, our Chief Investment Officer, Richard Flax, reviews financial markets in February reflecting on the ongoing situation in the Middle East and what it may mean for investors. You can also find a written version of his commentary below.

In a lot of ways, February continued the trends that we’d seen over the previous few months. Financial markets generally rose, with commodities and equities outperforming bonds. Within equities, the US stock market continued to lag, while European and Emerging Market equities outperformed. Within the tech space, we continued to see investors prefer tech hardware – memory producers and semiconductor manufacturers. There’s still a lot of uncertainty on the outlook for software businesses – as investors remain concerned that developments in Artificial Intelligence could significantly disrupt those businesses. 

On the fixed income side, in February we saw bond yields generally fall – with the UK 10 year yields dropping by around 0.3%. That helped support a decent return for fixed income ETFs in February. It’s also important for the Chancellor – who is looking for ways to free up cash. Lowering the cost of debt is a good way to do that, provided you can sustain it. And it allowed the Chancellor to increase her fiscal headroom in the latest Spring Statement. 

Key question for the month

The most relevant questions came just at the end of February: what is happening in the Middle East and what will the impact be on portfolios?

Last weekend, Israel and US aircraft attacked Iran. Iran responded with attacks against the US, Israel and a number of its neighbours in the Middle East. It’s impossible to know how long the conflict will last, or how wide the impact will be. While we are hoping for a swift and peaceful resolution to the conflict, we are also focused on the implications for client portfolios.

In general, after the markets reopened we saw oil and natural gas prices rise sharply, the dollar strengthened and risky assets like equities were generally weaker. It was also interesting to see that government bond yields rose, given concerns that higher energy prices could feed into inflation. Around 20% of global oil and gas goes through the Straits of Hormuz and shipping in the region is currently heavily impacted.

As we think about our portfolios, there are a few points to make. First, recent history suggests that we shouldn’t be too quick to act during periods of geopolitical crisis. Markets have generally rebounded quite quickly and a long-term focus has generally paid dividends. Second, we think that portfolios are generally well-diversified across countries, sectors and asset classes. Third, we think they’re fairly conservatively positioned and that we could use market weakness to add to some of our positions. 

There are some caveats. First, the longer the conflict continues, the greater the potential impact on the global economy – particularly if energy costs stay high – and it’s tough to know how long this conflict will last. Second, concerns about higher inflation can impact longer-dated government bond yields and we’ve already seen yields rise. That means long-dated government bonds might not be a great source of diversification. We prefer shorter-dated government bonds and recently reduced some of our long-dated UK government bond positions in the portfolios. We’ve also seen that US equities, so far, have held up better than some of their global peers. That’s partly thanks to a stronger dollar, but it’s also a reminder that the US is relatively more energy independent than many of its European peers. 

So for now, we’ll stay focused on the long-term while assessing the risks and opportunities in a volatile market environment.