View From The Top: Epic uncertainty

View from the very top: Investors are learning to live with volatility. Developments in the Middle East remain highly fluid. While we may be just one adverse headline away from panic, escalation benefits no-one. Assuming conflict eventually ends, the more important question is how long it takes for normalisation to return. Oil shocks tend not to fade quickly. A combination of demand destruction and tighter financial conditions could easily tip the economy into recession. Every prior recession since 1945 has been preceded by higher oil prices. No single policy fix can address all market fragilities. Investors will need to stay nimble. Opportunities will emerge. Risk assets could rally abruptly once a formal end to hostilities is finally declared. Ongoing asset class diversification represents the most defensible solution amidst epic uncertainty.

Asset Allocation:

Equities: 2026 continues to play out as the year for the stock picker. War has created massive disparities both across and within markets globally. US equities have outperformed relative to other regions, a reversal of recent trends and indicative of the country’s position as a net energy exporter and relative haven. Earnings revisions for the S&P 500 Index remain positive for now. The upcoming reporting season is likely to see a cautious tone on the part of corporates, even if it may still be too early to lower guidance ranges given ongoing conflict dynamics. Our approach is to favour truly active and differentiated managers and to consider contrarian opportunities, particularly given valuation dislocations that have recently arisen.

Fixed income/ Credit: Higher yields across the spectrum mean that the Bloomberg Global Aggregate Bond Index suffered its worst monthly loss in March for more than three years. Market consensus has shifted from the prospect of rate cuts to possible hikes, putting yields upwards. The refinancing of $10tr of US government debt in 2026 (per the US Treasury) adds an additional source of pressure. At the same time, private credit stresses are growing. With widening spreads, our allocations to this space are highly selective. Some opportunities may arise, particularly for those wishing to add duration.

Currencies: The rise in the Dollar over the last month represents not just the flight to safety that has occurred since Middle Eastern hostilities began, but also a reversal of prior recent underperformance. Mean reversion remains a powerful force in currencies. Dollar strength does adversely impact emerging market currencies in the near-term. Longer-term, the conflict may have broader consequences for the Dollar’s role as a reserve currency, reinforcing the case for diversification (and for gold).

Gold: Our view on the case for the precious metal remains unchanged, despite the recent sell-off. We have not been surprised to see the move down in gold over March, which to our mind constitutes both profit-taking and a reflection of higher yields elsewhere. Gold also tends to be inversely correlated with the US Dollar. Fundamentally, gold can serve as a diversifier. Central Banks continue to purchase the asset, while the growing likelihood of some form of future fiscal and monetary debasement should provide additional support.

Alternative assets: Hard assets should be well-positioned to benefit in periods of regime change and uncertainty (as well as those of higher inflation). Alternative assets can exhibit resilience as well as offering both portfolio diversification and income-generating characteristics. We favour selective investments, particularly in uncorrelated strategies.

Whatever else your views on Operation Epic Fury, or the third Gulf War, it has unleashed epic uncertainty for investors. This has played out across all asset classes. However, the sell-off has thus far been mostly orderly rather than panic driven. With the MSCI World Index down just 7.0% from its all-time high, there has been no sign of capitulation yet, not even a formal correction, although this move does clearly mask wide variations across markets.

Some may argue that the lack of investor panic may speak of complacency. At the least, the metaphorical wall of worry has become higher. As developments in the Middle East move into increasingly uncharted territory, it will become necessary to learn to live with volatility. Dislocations nonetheless create opportunities, and low prices can constitute attractive starting points for investors, even if timing entry points is inevitably complex.

The situation in the Gulf remains highly fluid. Conflict is now in its fifth week, yet investors continue to hope for a quick resolution. At the same time, potential for another ‘forever war’ cannot be totally dismissed. Recall that the Russia-Ukraine war has not been settled after four years of fighting. Further, consider that Donald Rumsfeld, the US Secretary of Defence under George W Bush, contended that the 2003 Iraq invasion would not last six months. It endured eight years and cost $3tr. Air power alone has never toppled a regime.

The Trump administration is having to learn to live with several harsh realities. First, Iran is clearly not Venezuela – there are no easy wins. For context, the country is the size of Iraq and Afghanistan combined. Next, war is not like Liberation Day. The stakes are considerably higher. You can’t call off a war in quite the same way you can reverse tariff decisions, especially without losing face. President Trump appears to depend on strength that comes from winning. If he is perceived to be losing, expect more retribution. The US clearly has a high motivation to state that peace is on the way, but there are only so many times that markets will believe the rhetoric of the President.

Against this background, we are arguably just one adverse headline away from panic. Conversely, escalation constitutes a win for no-one. There is hence a strong logic for a reversal of hostilities. Both sides, despite their public positions, would prefer an off-ramp. Meaningful hurdles to such an outcome remain, particularly given the contentious nature of both the American and Iranian regimes (albeit in very different ways). There is still significant scope for miscalculation, especially given the current asymmetry in the Gulf. Iran may be battered but it is not defeated. It has little to lose at this stage and can continue to keep the Strait of Hormuz shut for some time through relatively cheap and low-tech warfare.

Assume for now that the war eventually ends, or some form of truce that is credible to both sides is declared, then the next question that arises is how long will it take for the world to return to normal? There are always unintended consequences of conflict, especially in a (mid-term) election year. It is too early to know the full repercussions, both militarily and economically. Recent events in the Middle East may ironically encourage more nations to seek nuclear defence resources as a form of future deterrent. From an economic perspective, the shock to oil supply is highly significant.

Investors are arguably in denial. A parallel with the COVID19 pandemic may be relevant. Just as then there was a ‘belief’ in a swift reopening after initial lockdowns commenced, when reality hit, there was an abrupt reassessment. An end to hostilities in the Gulf does not equal a normalisation in economic activity. Remember, this conflict was one of choice, since no public evidence existed that the US faced an imminent threat from Iran. Equally, none of the stated goals of the Trump administration (denuclearisation, total defeat of the Iranian military, regime change) has been met. Instead, both the US and the world have been left with a developing energy crisis.. This weakens US credibility, both domestically and internationally.

Oil shocks don’t fade quickly. For context, US petrol and diesel prices are currently c25% and c35% higher on a per gallon basis when compared to levels at the pump prior to the inauguration of President Trump. Even were fighting in the Gulf to end tomorrow, then most commentators suggest that it could take four to six weeks to restart oil production in the region and up to two months to normalise shipping. Even then, there is a high likelihood of ongoing disruptions. Personnel may be unwilling to work, and insurance premiums would almost certainly rise. Consider too second-order consequences such as higher food prices (from elevated fertiliser costs) plus pressure in the semiconductor markets (chip manufacturers need helium, which is exported from the Gulf).

Think of higher oil prices as a tax hike on the overall economy, resulting in demand destruction, which brings down both economic activity and employment. Recall that consumption comprises c70% of US GDP. Practically, higher oil prices, higher bond yields and a stronger US Dollar all imply tighter financial conditions. This dynamic is negative for an already stressed private credit market, where Fitch is reporting record default levels in the US (since it first began tracking the data in August 2024).

No surprise then that the odds of a recession in 2027 are growing. Such an outcome may even become a self-fulfilling prophecy, the longer war goes on and given possible contagion effects (especially for credit, where non-bank lending has been a growth engine for mid-sized companies). All prior recessions since 1945 have been preceded by a rise in the oil price. Even before the attacks on Iran, the US economy had been in mixed health. GDP growth for the fourth quarter of 2025 was recently revised down to just 0.7%. Core inflation continues to run above the Fed’s target, while wholesale (producer price) inflation stands at its highest in three years.

To the extent that the 1970s represent a relevant playbook, oil shocks tend first to be stagflationary, and then recessionary later. The OECD has already revised up its forecast for inflation in the G20 nations to 4.0% for 2026, 120 basis points higher than its December estimate. Its growth forecasts have not changed significantly. To repeat, we are still in the denial phase. Wait until consumers stop spending, credit markets freeze up, and companies become reluctant to invest or to hire.

Policy mistakes may compound matters. Central Banks are having to absorb the uncomfortable reality of being caught between a weakening economy and rising prices. They have no power over what happens to the cost of a barrel of oil. Market forecasts have started to discount the possibility of rate hikes in 2026, as opposed to assuming cuts at the start of the year. Central Banks need to be seen to be talking tough. Only by tightening (or threatening to do so) can they hope to prevent energy inflation from leaking into the rest of the economy. At least for now, longer-term inflation expectations – as measured by five-year swaps – remain anchored.

What gives? No single policy can fix all fragilities. Before the war even started investors were having to contend with potential concerns over excess AI infrastructure build, private credit market stresses, stubborn inflation and job market stasis. Valuations on many metrics appeared stretched too. Fiscal stimulus options look increasingly unlikely given indebted governments, whose financial burdens only grow as war continues. If the Republicans lose the US mid-term elections – as currently seems probable – then policy paralysis may endure. We wonder then how long before Central Banks resort again to quantitative easing, with credit stress as the potential catalyst.

From an investment perspective, drawdowns are not only inevitable; they also constitute no guide to where markets will end the year. What we do know is that generally equities recover quickly from crises. In the immediate aftermath of ‘peace’ being declared, expect an abrupt rally, even if the distribution of gains will be uneven. Investors are currently sitting on the highest cash levels since March 2020 (equivalent to 4.3%), per Bank of America’s latest survey. Prepare for the worst but hope for the best. Progress from here will be non-linear, so stay nimble and keep diversifying.

Alexander Gunz

Fund Manager