Middle East optimism lifts markets
CIO Daily Updates
From the studio
From the studio
Thought of the day
Thought of the day
What happened?
The S&P 500 climbed 1.5% to a fresh record high on Wednesday and the price of Brent crude fell as much as 11% on renewed optimism that the US and Iran could be close to an agreement to reopen the Strait of Hormuz.
President Donald Trump said the Strait of Hormuz would be “open to all” if the Islamic Republic accepts the latest US proposals. Axios reported that the one-page framework would involve Iran agreeing to suspend further enrichment of uranium in return for the release of frozen Iranian funds and the removal of sanctions. Tehran, meanwhile, said it was reviewing the peace proposal and would convey its response.
Hopes for an end to the conflict led to a broad risk-on move. Alongside the 1.5% rally in the S&P 500, the 10-year US Treasury yield fell 8 basis points to 4.35% and the European Stoxx 600 advanced 2.2%. Asian equities also climbed to a record on Thursday.
What do we think?
Our advice through the conflict has been to remain invested and avoid “trading” geopolitical events. We have continued to view US and global equities as Attractive, while preferring to progressively derisk more energy-exposed markets.
Our base case has been that an eventual diplomatic solution would allow the focus of investors to return to resilient economic fundamentals, robust earnings growth, advances in AI, and the potential for further rate cuts from the Federal Reserve. The recent market rebound is consistent with historical precedent following geopolitical crises, with the S&P 500 trading higher after three months two-thirds of the time, based on data going back to 1940.
Focus is now shifting back to first-quarter earnings, with S&P 500 earnings on track to grow by around 17%—the fastest pace in four years. The AI theme remains a key driver, with strong results among large tech platforms and across the broader supply chain, including utilities and power-related businesses benefiting from rising data center demand. Earnings growth is also broadening across sectors, supported by resilient consumer spending and signs of a cyclical recovery. We continue to expect low double-digit earnings growth for the full year, with upside risks given the positive momentum and the expanding impact of AI across industries.
The rally on Wednesday provided another reminder of how a resolution to the conflict, or hopes thereof, can quickly drive markets higher. However, some caution is also still warranted. Iran has yet to agree to the US plan, and the publicly stated negotiating positions of the two sides remain far apart—including on issues such as Iran’s nuclear program, free transit through the Strait of Hormuz, and Iran’s support for regional proxies.
The lagged effects of the disruption remain to be fully felt, and it is also not clear how quickly, and to what extent, traffic through the Strait will normalize. Shipowners and insurers could remain skeptical about the safety of travel through the waterway. Against this backdrop, while we retain an Attractive stance on most global equity markets—including the US, China, Japan, and Switzerland—we remain Neutral on the Eurozone and India due to their greater sensitivity to higher energy prices.
How to invest?
The recent resilience in markets provides investors with an opportunity to rebalance from a position of strength, positioning to benefit from further market upside while diversifying potential risks.
We favor several strategies for doing so:
Diversify equity exposure. The recent rally has seen an outsized contribution from large-cap technology firms, and global indices have become increasingly concentrated in a few companies. This leaves portfolios more exposed to positioning risk, particularly when the next phase of the cycle is likely to introduce new competition for capital.
Investors can address this risk by complementing exposure to market-cap-weighted indices with equal-weighted index approaches, or by adding exposure to our preferred markets such as Japan, emerging markets, China, and Switzerland.
Investors can also broaden exposures to megacap tech across the enabling, intelligence, and application layers of the AI value chain, including semiconductors and chipmaking equipment, power and resources, and infrastructure. We also favor diversification across our Transformational Innovation Opportunities, including Longevity and Power and resources.
Locking in yield. Investors who have seen the equity share of their portfolio grow amid the recent rally could rebalance some of that exposure to quality bonds, to bring allocations back in line with long-term plans. In our view, markets have exaggerated the risk that central banks will tighten policy in response to higher energy prices. We believe the recent rise in government bond yields in USD, EUR, and GBP provides an opportunity to lock in elevated yields and diversify portfolios.
Phase into markets. Investors who are underinvested should consider phasing into markets. While many investors feel wary about investing in equities at record highs, our analysis indicates that all-time highs have not historically been materially riskier times to add to exposure. Since 1960, the S&P 500 returned 11.8% over the next 12 months and 22.8% over the next two years on average after an all-time high, versus 12% and 25%, respectively, when trading below a record high. We think that whether earnings expectations continue to rise and whether policy remains supportive remain more important factors.