How would the conflict in the Middle East impact on investment returns?

• A prolonged disruption in energy and petrochemical supplies would pose the challenge of high inflation and weaker growth. This could delay rate cuts by central banks, including the U.S. Federal Reserve, or even prompt some to raise rates to stem inflation. Meanwhile, governments are also expected to expand fiscal policy to protect households and businesses from higher energy and food prices, leading to a rise in fiscal deficits. (GTMA P.17)
• While some investors may compare this round of geopolitical conflict with the Russia-Ukraine war that led to a spike in inflation in 2022, there are significant differences. The global economy was recovering from the pandemic in 2022, with both fiscal and monetary policies being extremely accommodative. At that point, central banks needed to raise interest rates rapidly to curb inflation. Monetary policy in most economies now would be at a neutral position, if not slightly tight. (GTMA P.15 & 61)
• This implies the potential drawdown for fixed income should be less severe than 2022. For equities, the global economy was riding on steady momentum and earnings growth outlook before the war began. 2026 earnings downgrade would be linked to the duration of energy supply disruptions. (GTMA P.67)
• In the longer run, there could be some long-term structural implications. More economies should look to diversify their sources of energy away from the Middle East. This could potentially lead to greater demand for shipping capacity to move energy products around the world. Moreover, this round of supply shock should restart public discussion of being more proactive in non-fossil fuel energy, such as wind, solar, hydro-electric and even nuclear. The infrastructure investment could be another area that investors could participate. (GTMA P.19)

What’s next in the global development of artificial intelligence? 

• The long-term use case for artificial intelligence (AI) remains very positive, and adoption is taking place. That said, investors are asking the right questions on the return on investment from huge capex spend on data centers and compute power. This has led to a more subdued performance for AI hyperscalers in recent months relative to the S&P500, as investors are trying to work out which AI models would see wider adoption. (GTMA P.51)
• Investors are also starting to make distinctions over companies that could compliment AI development, as well as those that could be at risk from more AI functionality development. Robotics and autonomous driving are good examples of hardware that could broaden the use case of AI in manufacturing, logistics or other labor intensive industries. Meanwhile, we have already seen the Software as a Service (SaaS) sector under pressure, even though those with high volume of data, robust security framework and those who have already integrated with their clients’ process flows should remain more resilient. (GTMA P.52)
• The data center components, such as GPUs, memory chips, and assembly of these components remain vital to the development of AI, regardless which model comes out on top. Asian economies, especially South Korea and Taiwan, have particularly strong comparative advantage in this area. (GTMA P.42)

Why is income generation important?

• Income from assets often represents a more consistent cash flow that provides stability during periods of high market volatility. The compounding effect from income being re-invested is also often overlooked by investors when they are only focusing on short-term capital gains. (GTMA P.85)
• Income can be generated as yield from fixed income, dividend from equities, income from alternative assets, such as real assets and private credits, or options premium from equity strategies. (GTMA P.78)
• Despite the volatility from the conflict in the Middle East, we still see high yield corporate debt to be a good generator of income. The U.S. economy is likely to remain relatively resilient that should keep default rate manageable. (GTMA P.64)
• The option premium from equity strategy is typically higher during periods of high market volatility. This can help to offset some of the short-term correction in the equity market.
• We acknowledge recent investors’ concerns over private credit. Yet, it is important to recognize that managers’ ability to manage credit risk is key in long-term returns. Investors should also be aware of the liquidity constraints on these alternative assets position accordingly. Relative to public market debt, investors are being compensated for locking up their capital for a period of time. (GTMA P.77)

How should investors allocate their money?

• Over the medium term, we remain constructive on the global economy and the development of AI. This naturally points towards a more pro-risk stance in asset allocation. This favors equities and corporate credits.
• For equities, we remain constructive on U.S. equities. Investors should broaden their allocation towards sectors such as financials, industrials and healthcare, given the growth momentum. We also see opportunities in Asian equities that feed into the AI evolution, whether this is component makers in Taiwan and South Korea, as well as Chinese companies that are supported by government policies to become self sufficient in technology and other strategically important products. (GTMA P.53)
• For fixed income, high yield corporate debt and U.S. dollar-based emerging market fixed income can generate yields for investors even as credit spreads are relatively tight. The uncertainties on fiscal policies could still persuade investors to remain short duration in developed market government bonds. (GTMA P.57)
• In the short term, as the geopolitical conflict continues, investors may opt to maintain liquidity and look for opportunities to bargain hunt, even though timing the market is incredibly challenging. We suggest investors should stay invested, while focus on high quality credits, such as investment grade corporate debt, and companies with strong balance sheets and a resilient business model towards higher energy costs and supply disruptions.