Our investment strategy as Middle Eastern tensions continue

Investors spent the week watching the conflict between the US/Israel and Iran. The geopolitical significance is clear and remains a key downside risk.  

Oil has moved higher as investors price the risk of supply disruptions. Traditional safe-haven assets such as government bonds have underperformed, given inflation worries triggered by rising oil prices. As the conflict started, we reduced our exposure to US Treasuries and UK gilts, which is helping portfolios. 

Gold turned out to be volatile too, with some investors selling it to cover losses in other parts of their portfolios. That said, we believe gold can provide protection against geopolitical and inflation uncertainty, as it has in past episodes. We recently increased our gold exposure to an overweight position. 

Equity volatility rose but remained within historically normal ranges for periods marked by geopolitical uncertainty. This isn’t unusual. Geopolitical shocks tend to shake markets for some time, but unless they alter global economic fundamentals, the effect rarely lasts. Once the initial shock fades, investors typically refocus on growth trends, earnings and the policy paths of central banks and governments. Those are the real drivers of asset prices over time. 

The key question is whether the conflict drags on and disrupts global energy supplies or proves short-lived, with limited damage to energy infrastructure in the Middle East. If oil keeps flowing, the economic fallout should remain manageable. A lasting supply hit would be a different story, pushing inflation higher and complicating the outlook for earnings growth and interest rates. 

Our base case is that the conflict stays relatively contained and doesn’t extend beyond a few months. The main economic channel is energy commodities. If oil and gas prices stay elevated, though only temporarily, we could see a short period of mild stagflation: slightly weaker growth paired with slightly higher inflation. 

Our scenario analysis suggests a modest hit to economic growth across the US, Europe and several oil-importing emerging markets, with only a small rise in inflation. That kind of move is unlikely to force central banks into major changes to interest rates. Oil-exporters, naturally, would benefit. 

Once the initial pressure on energy prices eases, fundamentals should reassert themselves and provide a constructive backdrop for markets: monetary and fiscal support remains in place and the investment cycle linked to artificial intelligence remains strong.  

A drawn-out conflict lasting more than six months, on the other hand, would increase recession risks by keeping energy prices higher for longer. That would make the market environment harder to navigate. 

Our portfolio positioning reflects this balance. We hold a moderate overweight in equities and underweight in bonds, supported by risk mitigators designed to cushion potential shocks. Portfolios remain broadly diversified across geographies and asset classes, which helps cope with volatility without sudden changes. Where possible, we also use insurance-like instruments that appreciate when equities fall, helping dampen downside risks. 

The core message stays the same. Rather than react to headlines, we recommend planning ahead, stress-test the key assumptions and prepare for a range of scenarios. The current situation may create temporary stagflationary pressure but, at this stage, it doesn’t alter our medium- or long-term outlook. Our approach remains patient, disciplined and focused on fundamentals. 

Developments in the Middle East are likely to remain centre stage, with investors very focused on any sign of de-escalation for a more positive tone or, vice versa, escalation (especially if it was to disrupt energy supplies and flows) for a more negative tone.  

Markets will also pay close attention to a new round of inflation data. In the US, February’s inflation figures (Wednesday and Friday) will be crucial to get a sense of price pressures and any implications for the interest rate trajectory, but investors won’t have able to gauge the effect of rising oil prices with this data release.