Demand shocks defined the challenge for investors in the 2010s. The central challenge for investors over the past few years has been something else altogether - an unrelenting series of supply-side disruptions. They began with Covid pandemic bottlenecks and were followed by the Russia-Ukraine energy crisis, the most aggressive U.S. tariff regime in a century and, now, the closure of the Strait of Hormuz and the beginnings of what could become the most acute oil supply disruption in history.

Stagflationary pressures created by the disruptions leave policymakers with no good policy options and often lead to breakdowns in typical stock-bond correlations as well as a widening distribution of inflation and growth outcomes.

In this report we explore the economic and market forces in play, identify investment opportunities and broadly reaffirm our modestly pro-risk over the next 12-18 months (although we have trimmed back risk in some portfolios).

Macroeconomic and policy views

As of this writing, Brent crude derivative markets are not pricing in a long-term and sustained acute oil disruption, but they are pricing disruption that may last longer than originally expected. Arguably the most significant market impact of the Iran war so far has been the rapid repricing in near-term central bank paths (central banks like the Bank of England (BoE) and the European Central Bank (ECB) have multiple hikes priced in instead of rate cuts) while long-term inflation expectations across developed markets generally remain well-anchored (Exhibit 1).

This suggests to us that markets are broadly pricing in an episodic oil spike, but one that is not yet extreme and persistent enough to lead to either a de-anchoring of long-term inflation expectations or demand destruction that significantly increases recession risk.

The current situation differs markedly from the 2022 oil spike that led to a sustained inflationary spiral and a Federal Reserve (Fed) hiking cycle. The global economy will largely be able to manage through this shock, we believe, as long as the shock is well-contained. On the inflation front, the oil shock is being absorbed by an economy with headline inflation below 3% – rather than over 7% as in 2022 – and with significantly elevated policy rates. Today, inflationary pressures in the U.S. are largely decelerating (for example, shelter) or scheduled to decline later this year (tariffed goods) rather than broadly increasing as they did in 2021-2022.

On the growth front, before the conflict began the global economy was relatively strong. In the U.S., market participants expected that fiscal and monetary tailwinds would work in tandem: roughly USD 250 billion in new spending from the One Big Beautiful Bill Act, the pass-through of last year's Fed rate cuts, and delayed impacts from the government shutdown resolution. Additionally, up to USD 150 billion of IEEPA tariff refunds could provide a notable, if lumpy, boost to corporate cash flow.

Outside the U.S., growth in the pre-Iran war period was broadly picking up. Expected growth differentials between the U.S. and developed economies such as the eurozone and Japan were narrowing as those regions are adopting more active fiscal policies.

Where could our outlook go wrong? The market could rapidly reprice for a longer, more damaging conflict if fundamentals change on the ground, leading to a sustained risk-off move. Unlike previous geopolitical episodes under Trump 2.0, complicating factors make it more difficult to declare a straightforward U.S. victory. We could see damage to energy infrastructure and transit routes that takes months if not years to repair.

A prolonged, widening regional conflict could cause a pullback in consumer spending and an erosion in business sentiment globally. That could constrain growth, possibly in ways that are both non-linear and accelerating. Of all major regions, the eurozone appears to be most at risk. Importantly, across the global economy, we see no good policy response – whether strategic petroleum reserve releases, oil export bans, or regulatory waivers – that would be able to alleviate this supply shock. Ultimately, the only solution is to restore the free flow of goods through the Strait of Hormuz chokepoint.

Core views across assets and sectors

We turn now to our core views. These serve as the backbone of our multi-asset portfolios.

Despite recent developments in the Middle East, our asset allocation views remain modestly pro-risk over a 12- to 18-month investment horizon, even as we have trimmed risk across certain portfolios. This stance primarily reflects our view that global growth should prove resilient if geopolitical conflict remains contained and short-lived, while inflation dynamics become more two-sided. Broadly, we lean into a diversified basket of equities that help provide balanced exposure during a period of tumult, and we express a short duration bias through U.S. Treasuries that has been additive since the start of the Iran conflict.

In the U.S., we overweight equities with a focus on technology and communication services, where secular earnings drivers—artificial intelligence (AI) infrastructure, cloud, software productivity, and digital advertising—can compound in what is still a constructive macro environment. As long as the primary market risk of the Iran war is higher energy prices over just a short period of time, the thesis for these sector overweights still holds. That is: tech and communication services sectors’ cost structures are far less sensitive to oil than other sectors, the AI capex cycle should remain relatively resilient, and the superior profit margins and balance sheet strength of companies in these sectors should provide a buffer against a more challenging economic environment.

Separately, before the war started we had forecasted only one Fed rate cut, and the market is now expecting the Fed to remain on hold. We still believe the Fed will likely cut later this year. Further, we had adopted a short duration stance through 10-year Treasuries as yields rallied well below our estimated trading range of 4.2%-4.6%.

Post-war we have neutralized our credit exposures given an increasingly asymmetric return profile that skews to the downside. While we do not underweight credit, we recognize that in the event of a true risk-off move, our high yield position would come under pressure. Indeed, if oil volatility were to decline while spreads widened even further, we could see that as an opportunity to add (Exhibit 2).

Outside the U.S., we overweight Japanese equities. Japan’s economic cycle is in an earlier (and less complicated) phase than other developed economies and its economy can draw continued support from corporate governance reform. Rising real wages and continued fiscal support should help underpin overall economic activity. At the same time, normalization of Bank of Japan (BoJ monetary policy—now likely to proceed with an April 2026 hike supported by wage-price dynamics—signals confidence rather than constraint. We could add to our Japanese equity position if we were to maintain our confidence in fundamentals while seeing a further drop in forward P/E in Japanese or emerging market (EM) equities and evidence of positioning washout.

In Europe, we are long Italy and UK government bonds and overweight the euro. We expect that the deposit rate will remain stable this year as growth concerns limit hawkish policy action. This should support an environment of benign interest rate volatility in the eurozone and create selective opportunity in places like Italy where long-term interest rates provide a healthy income pickup over German Bunds. Finally, a stronger euro is consistent with narrowing transatlantic policy differentials and a healthier growth mix. However, we continue to pressure test that view given the disproportionate impact of the Iran war on the euro area economy.

Across emerging markets, we overweight equities to capture tailwinds from an improving nominal growth and policy outlook. China’s gradual reflation story—supported by targeted credit easing measures, prospective policy rate cuts, and a reduction in reserve requirements — pushes the growth path toward 4.9% for 2026, above consensus and aligned with official targets. This dynamic should help support the Asia-Pacific economy more broadly.

That said, we recognize that higher energy prices will affect the trajectory of EM growth, inflation, and monetary policy this year, leaving us less enthusiastic about dollar-denominated EM debt than we were at the end of last year. We thus prefer to express EM risk through equities rather than hard currency paper.

Exhibit 3 shows the past year’s returns vs. history across global markets. 

Opportunistic views: Idiosyncratic and short-term potential

Beyond our core views, our opportunistic views look to take advantage of short-term, idiosyncratic opportunities across the capital markets. Today we see several that generally align with our pro-risk view or provide diversification beyond what can be distilled from traditional stocks and bonds.

As an example, we believe that the recent Iran price action has provided an added reason to be bullish 10-year U.K. Gilts, given that we believe the market has overly repriced the central bank path and the sell-off was largely technical in nature. We are funding this trade with a blend of 10-year U.S. Treasuries and 10-year Australia government bonds, reflecting the persistent inflationary pressures confronting the Reserve Bank of Australia.

We also see an opportunity to continue to go long procyclical currencies while being selective in differentiating between regional energy exposures. For example, in Europe, we are using the euro to fund a long position in the Norwegian krone, given Norway’s status as a premier energy exporter and the currency’s high beta to oil prices, rather than currencies like the Swedish krona.

Finally, we believe that gold can continue to diversify in an environment where equities and bonds are positively correlated. Anticipating continued strong demand for gold from central banks and other buyers with conviction in the commodity’s long-term potential, we see a strong case for gold’s outperformance over the next 18 months.

Despite gold’s weak performance in the first two weeks of the Iran shock, it is notable that gold is still up year-to-date after averaging about $3,300 in 2025. We believe that the current sell-off can be best described as a value at risk (VaR)-type stress shock – and one where typical correlations temporarily but not permanently break down. In sum, we believe that gold’s fundamentals remain intact, and if anything, its depressed prices can provide an attractive entry point for investors.

Alpha opportunities, correlations and volatility

Today’s market presents a range of interesting alpha opportunities. In the U.S., unusually high value dispersion indicates a rich opportunity set for value-oriented stock selection. In our view, the large gap between cheap and expensive names allows managers to target top-value cohorts. The U.S. market also shows a notably wide value spread in the quality factor (higher valuation differentials between the best and worst quality stocks), creating room for active stock pickers.

In Asia ex Japan, a similarly elevated value spread of the quality factor argues for multi-factor constructs that combine value and quality—an opportunity to harvest alpha from mispriced fundamentals while keeping cyclicality in check. By contrast, the opportunity set is thinner where dispersion is depressed. Japan and the developed markets more broadly exhibit unusually narrow spreads between value and quality factors. This implies that factor-based alpha is harder to extract in the current environment – even as Europe and Japan still see elevated momentum dispersion, indicating that the market continues to reward winners vs. losers.

More broadly, stock-bond correlations remain relatively well behaved at 0.1 – in positive territory but still close to zero. We anticipate that these correlations will rise over the short term as the Iran shock leads to sell-offs in both equities and bonds (although we acknowledge the possibility that correlations turn more negative if deteriorating economic fundamentals cause investors to worry more about a growth scare than an inflation scare).

The VIX Index measuring stock volatility is now at its highest level since Liberation Day (the sudden announcement of U.S. tariffs in April). But the MOVE Index, which measures U.S. bond market volatility, remains slightly more well behaved on a historical basis as of this writing. We are monitoring the MOVE index closely given that persistently heightened bond volatility can lead to more limited equity upside. 

8b86054b-0573-11f1-afbc-c1d29ed6810a