Our guest author on all things geopolitical (and long-standing client) Stephen O’Sullivan had recently asked me, “what will bring this equity rally to an end James?”. He was referring to the rest of the world rally as opposed to US equities, which had already effectively stalled out. “They always end”, he sagely noted, and this week in an email he wrote, “we should have known it would be Trump”.
What Happened
I guess we should not have been too surprised. The build-up of military hardware in the Middle East had been well telegraphed, along with Trump’s promise to Iranian protesters that he would do something. Last Saturday we found out what that ‘something’ was going to be. No doubt spurred on by the success of his Venezuelan exercise and persuaded by Israel of the opportunity that weekend, operation ‘Epic Fury’ was launched.
What Happens Next?
Since Monday, great minds and experienced commentators have been speculating as to what happens next. The analogy of a garden weed was given to me by Christopher Grenville at TS Lombard, using the weed as a metaphor for the incumbent Iranian regime. The weed could be chopped off now at ground level, but the roots would be still in the ground. Risk consultants Flint Global, who we know well, came up with four possible scenarios. Two involved leaving the roots in the ground, a relatively quick end to ‘Epic Fury’, but work still to be done around the regrowth. Two involved digging the roots out, which would clearly take longer, one with a positive ultimate outcome and a new progressive Government in Iran, and one resulting in a mess with no one faction in control.
TS Lombard were optimistic of a quick ‘roots still in’ solution, buying time for a more permanent solution. I am fairly sure this would be Trump’s preferred outcome, so that he can declare a massive victory in the coming weeks. Israel may see the opportunity to go after the roots while the weed is much weakened.
What is for sure is that Trump has less control over the situation today than he had in the aftermath of Liberation Day last year. Last year, as soon as markets slid against him substantially, he backed off – the famous TACO ‘Trump Always Chickens Out’ trade. This time it’s a military event, which no doubt his adversaries largely saw coming, and had something of a dress rehearsal for in the 12-day war of last year.
The tail risk here of a longer drawn-out affair, dragging in other countries and the economic impact that could have, feels higher to me.
The Impact On Our Portfolios
Only time will tell how thorough the ‘weeding out’ is going to be and how long it takes. So far, equity markets seem happy to hold onto the TS Lombard view and the damage done (so far) is not too bad, especially when looked at on the three-year view.
Note that these charts are as of this morning’s fund prices and show the returns net of the fund fees only, Tideway’s fees must be deducted to see your portfolio net returns.
1 Week return:
3 Months returns:
3 Year Returns:
What has Happened?
In Fixed Income
The conflict adds to inflation expectations as the price of Oil and Natural Gas rise. Previously ‘priced in’ expectations for base interest rate cuts in 2026 will be at risk and could be off the table in an extended conflict. Longer term yields have risen, which have been a recent headwind in the last week, and credit spreads have similarly widened.
But this is not a repeat of 2022. In 2022, 10-year gilt yields rose by 450% from 0.8% to 4.4%, having been as low as 0.2% in 2020. So far in the last week, 10-year gilt yields have risen just 7% from just over 4.2% to just over 4.5%. That’s still a decent dent if you own a long duration gilt. The iShare Core UK Gilt ETF at the heart of most passive fixed income portfolios is down 2% in five days and will take around six months of interest payments to recover that capital loss. Our actively managed short duration corporate bond funds are down less than 1%, and with yields over 6% will take but a few weeks to recover the capital loss.
It is worth remembering that when bond capital values fall through, either rate rises or credit spreads widening the future return over the next 12 -18 months just goes up.
In Equities
Equities have been behaving to type; they have become much more volatile. The South Korean index fell 12% on one day, with circuit breakers employed to keep the market orderly. It rose 8% the next day and, as I write, is still up 32% year to date.
The ‘risk off’ sentiment has driven investors (traders!) back to the US dollar. Since Saturday, some of our relative gains versus US indices converted into sterling have narrowed.
I did ask Christopher Grenville if he thought the US to the rest of the world rotation was ended by the conflict and he thought not. The chart below from Azuria Capital, spotted by our investment team on LinkedIn, compares the rest of the world equity returns versus the US S&P 500 – it paints a great picture. There is plenty of space for the rotation to run and run.
At the company level, the play book is predictable. Airlines, cruise companies, and anything travel related has been hit hard. If bond yields keep rising, expect growth stocks like tech, already stalled out, to take more pain. Energy and defence are doing well.
Alternatives
Surprising some investors, the price of Gold and Silver, seen as safe haven assets, also fell this week. Silver is off 11% in five days, Gold a more modest 2.6%. Both are impacted by a stronger dollar and both probably suffered from margin traders having to sell to cover their leverage.
The sell off in equities has so far been relatively modest, so there have been no big profits for derivatives traders.
What We Can Remind Ourselves of From the Weeks Events
- Geopolitical risks are real and the behaviour of Governments and individual politicians, especially when they are the POTUS, can have a big impact on investment markets and global economies. We must keep abreast of them.
- You need to act ahead of events like this rather than trying to trade portfolios in a crisis. Imagine selling a South Korean fund, which traded at Wednesday’s price, only to miss an 8% recovery by one day!
- Equities will always be volatile, and they have the propensity for significant down turns in value on largely unpredictable events. We know recoveries from such falls aren’t always so fast.
- By contrast and except in extremis, fixed income returns are more stable and more predictable than equities.
On point 2: Nick Gait highlights below the actions we have taken in recent months and before Saturday to protect portfolio values.
On 3 and 4 this is a real-life example that brings home the importance of planning our portfolios. The equity bond trade-off has changed considerably from 2022 as can be seen in the 3-year chart. Our bond funds are delivering a very consistently high single-digit return – the ‘tortoise’ is trotting along nicely!
If inflation is higher in the long term it is still likely to be better to own equities, but equity investors need be comfortable with the volatility and be ready not to touch their equity investments for a good few years in the event of a larger more prolonged downturn.
What Should We Be Doing Now?
With relatively highly valued equity markets and heightened geopolitical risks, we have already acted at the portfolio level. However, it’s not too late for individuals to act to make sure their investments are planned correctly.
My advice is that (just in case!) we all need to be making sure we have enough bond and liquidity investments to be able not to touch your equity investments for at least 10 years. Over that timeframe, the extra risk of equity investing will more than likely be rewarded.
Plus, if you are well funded for the future income you need, just how much of your money do you really need to have running on the ‘hare’, when the ‘tortoise’ is going to get the job done in a much more relaxed way?
If you have been in equities for the last few years – and particularly US equities up to 2024 – then you will likely have had pretty strong returns. It’s not too late to take profits and take some risk off without denting your long term returns too much.
Tax Planning
Finally, we have published a tax year end check list which includes the allowances that pass by and things that are changing on 5th of April. Our advisers are here to make sure you don’t miss anything, please use them.
Please note that in writing this week’s update, we have focused on the impact of this week’s events on our clients’ portfolios. The Tideway team are also acutely aware of the humanitarian issues caused by these events.
