Rebounding from a supply shock

Supply shocks, which push inflation higher while weighing on growth, are among the most challenging environments for investors to navigate. They have also become more frequent. The recent spike in oil and gas prices tied to the conflict in Iran marks the fourth major supply shock in just the past few years, following post-COVID supply‑chain disruptions, the Russia–Ukraine war and the introduction of tariffs.

The core challenge is that traditional safe havens don’t always work in the face of a supply shock. Higher inflation leads markets to price more hawkish central banks, putting pressure on bonds and raising the discount rate applied to risk assets. Persistently elevated and volatile inflation has kept the stock–bond correlation generally positive since COVID, after nearly two decades of sharply negative correlation.

Alternative diversifiers such as gold can also be unreliable, as has been evident in recent weeks. Higher real yields and crowded positioning can trigger liquidations in metals, even when rising geopolitical risk would, in theory, support prices.

Currencies have also behaved inconsistently. In the current episode, the USD has benefited from the US’s relatively strong energy position vs. the rest of the world. However, the dollar sold off sharply when tariffs were introduced, as global investors reassessed their exposure to US assets. Meanwhile, the traditional safe‑haven JPY has struggled, reflecting Japan’s vulnerability as a major energy importer.

We recently discussed how investors can build more resilient portfolios for supply shocks through alternatives. CPI‑linked infrastructure and certain hedge‑fund strategies stand out as ways to offset some of the pain. Targeted exposure to specific commodities can also help, particularly when the commodity itself is at the center of the supply shock. Still, in this episode, unless investors entered with meaningful exposure to energy‑related assets – which had underperformed for years – most portfolios have experienced some pain in recent weeks.

One silver lining is that supply shocks do eventually end. One way or another, supply adjusts, even if the new equilibrium price settles at a higher level than before. In isolation, supply shocks typically lead to a de‑rating of risk assets, which is what we have seen so far. The more important question is whether the shock becomes severe enough to push the economy into recession, as that is when equities and credit tend to experience their largest drawdowns. 

Developments remain fluid, and economic damage has already occurred following the closure of the Strait of Hormuz and the destruction of some Gulf energy facilities – the key question is the magnitude of the impact. Higher energy prices will lift headline inflation and weigh on real incomes, placing downward pressure on consumer spending. That said, the timing of the shock is relatively favorable, as it coincides with fiscal support from the US tax bill and German fiscal stimulus entering its economy. In addition, global manufacturing momentum had already been improving, as reflected in the February pickup in global PMIs. If a shock was going to occur, this was not an especially unfavorable point in the cycle. Private‑sector balance sheets remain healthy, limiting the risk of a sharp retrenchment. Assuming the Strait of Hormuz is gradually reopened and oil prices avoid multiple months above USD 120, the economy should have sufficient resilience to muddle through.

We also expect the inflation shock to remain largely concentrated in energy and agriculture (which is feeling the effect of a spike in fertilizer prices). If that turns out to be the case, it could keep inflation from broadening meaningfully into manufacturing and services as it did in 2021–2022. The earlier episode reflected a combination of pandemic‑related factory shutdowns and an abrupt demand surge fueled by overstimulus from government tax relief and spending programs. Today, even with fiscal support in place, US nominal GDP growth is running closer to 4%–5%, compared with double‑digit rates during that period. The labor market is also materially less tight, reducing the risk of a wage–price spiral.

Against this backdrop, we believe the recent hawkish repricing of central‑bank policy expectations has overshot. Given single inflation mandates and high reliance on imported energy, it is understandable that markets have priced rate hikes in the UK and Europe, although we believe expectations have gone too far given the negative growth implications. By contrast, the Fed’s dual mandate – which includes full employment as well as price stability – leaves room for rate cuts later this year, assuming core inflation continues to normalize toward 2% as we expect.

Markets entered the year pricing an improving growth–inflation mix; the war has degraded, but not fundamentally upended, that dynamic. Despite volatile headlines, underlying earnings growth has remained strong and has, unusually, been revised higher this year. Against this improved earnings backdrop, the S&P 500 forward P/E has de‑rated by roughly 15% since October, representing a meaningful adjustment. Sharp swings in sentiment and positioning have also triggered several of our contrarian buy signals, which have historically back-tested well. As a result, we remain overweight equities, with a preference for emerging markets and Japan, where earnings growth remains strongest. We hedge this exposure with an underweight to Europe, where earnings growth is weaker and vulnerability to higher natural‑gas prices would increase should the Iran war escalate.

We also find duration increasingly attractive, as the shift in central‑bank pricing appears extreme. De‑escalation between the US/Israel and Iran would reduce inflation risks, while a more adverse scenario of sharply higher energy prices would ultimately weigh on growth and force central banks to ease. Recessions tend to extinguish inflation, and we have conviction that bonds would regain their hedging properties in that environment. While we have not formally moved overweight duration given the still‑positive stock–bond correlation, government bonds are increasingly attractive on an outright basis.

We remain neutral on credit. Although spreads have widened modestly, the asymmetric return profile leaves credit less compelling than equities at this stage. In addition, we see scope for private credit investors to hedge exposures through more liquid public‑market instruments.

We removed our USD underweight during the escalation of the war, reflecting the US’s relative insulation from energy shocks, given its role as a major producer. That said, we continue to favor selective carry opportunities, particularly in BRL, which continues to offer attractive yield.

Finally, while gold remains part of our Strategic Asset Allocation, we have shifted from overweight to neutral in Tactical Asset Allocation. Gold has become too correlated with risk assets to justify additional tactical exposure. We continue to see a structural case for higher central‑bank and private‑sector holdings over time, but we view this as a strategic allocation rather than a near‑term tactical trade.

The chart below shows the views of our Asset Allocation team on overall asset class attractiveness for global equities, rates, and credit as of 24 March 2026. The rest of the ratings pertain to the relative attractiveness of certain regions within the asset classes of equities, bonds, credit and currencies. Because the Asset Class Views table does not include all asset classes, the net overall signal may be somewhat negative or positive.