De-risking during uncertainty
Geopolitical uncertainty continues to be a key theme for investors. Although there have been some initial signs of de-escalation in the Iran war, energy disruptions persist. Our base case remains that energy disruptions will end over the coming month, but the probability of more severe scenarios increases over time. These risks do not appear to be fully priced into equity markets. We therefore reduce our equity positioning to neutral. Our positions in bonds and gold remain unchanged, meaning we are neutral on bonds and positive on gold.
Equities: A more cautious approach
Since the start of the Iran war, there have been early indications of easing tensions, but the Strait of Hormuz is still closed, and peace talks are going slowly. The war has shifted from a full-on war to an economic one. Even so, equity markets have shown resilience. In fact, they have recovered most of the initial losses and in some cases even set new all-time highs. The fear in the market has eased, while the disruptions in energy markets are greater than ever. This can be explained by strong corporate earnings and earnings growth expectations are also at high levels. IT and semiconductors, particularly, have been driving growth. This is in line with our recent change to increase our weight in the IT sector.
However, after the recent recovery, we think that the ongoing uncertainty is not fully priced in anymore. Markets appear to fully anticipate a quick resolution even though uncertainty is high. The strong rally has also reduced the room for further upside, while increasing the risk of a more pronounced downturn should a negative scenario materialise. The probability of this has increased and would lead to weaker economic growth and higher inflation than currently expected. We want to be cautious in the current environment, as setbacks could unsettle markets again.
We have therefore decided to reduce our equity positioning back to neutral to de-risk in a time of ongoing uncertainty. Our regional positioning remains unchanged. We are cautious about Europe, neutral on the US and positive about emerging markets. The latter should benefit from relatively high economic and earnings growth compared to other regions.
Conclusion
The prolonged uncertainty around the Iran war and the ongoing energy disruptions pose a growing risk for equity markets. While the largest disruptions may ease in the short term, the likelihood of a more adverse scenario has increased, which could raise the downside risks for equity markets. Following a strong rally in equities, we therefore see this as a good moment to reduce risk in the portfolio by reducing our allocation to equities from a slight overweight to neutral. Meanwhile, our views on bonds and gold remain unchanged. For bonds, we prefer high-quality (HQ) bonds over high-return (HR) bonds since credit spreads, which are compensation for additional risk, are still too low in our opinion. Finally, gold provides diversification in the portfolio while benefiting from long-term structural trends.