Investment Viewpoint: markets steady despite geopolitical tension

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Markets and macro insights with Sebastian Orsi, Senior Research Analyst

Key Takeaways

• Global equities were up about 1.5% last week led by Europe. Euro area bond markets were up 0.7% as government bond yields declined.
• The impact of the Iran war-related energy price increases and supply disruption is evident in current economic data that indicates a more severe slowing of economic activity in Europe than in the US. The longer the current stalemate lasts, the greater the impact will become. Rapidly depleting oil and product inventories are increasing concerns.
• Our investment strategy remains slightly pro-risk, with a bias to quality and structural growth.

What happened in financial markets last week?

• Global equities and euro bond markets finished the week higher after some mid-week ups and downs.
• Equities were led higher by Europe, which rallied more on signs of de-escalation in Iran given its greater economic and market exposure to energy security risks.
• Equity sector performance broadened last week, a welcome change from recent trends. While defensives generally outperformed, cyclicals were also up. IT outperformed but Communication Services declined.
• Earnings from the late reporting US bellwethers supported the current narrative. The AI/technology investment theme remains strong for the foreseeable future. The US consumer economy remains split, with lower income households feeling more of the impact of higher energy prices and inflation in general.
• European bond yields initially rose, before settling lower on the week. German 10-year bund yields fell 0.11%, while other European bond yields fell even more. US treasury yields were mixed: 10-year yields came down slightly, but 2-year yields rose, reflecting increasing conviction the US Fed may need to raise policy rates. Yields remain near recent highs in both regions as bond investors remain focused on the near-term inflation implications of the Iran war more than the potential growth downside risks.
• The euro weakened against the US dollar steadily through the course of last week despite the de-escalation signals and equity market performance.

What does it mean for investors?

• Markets are moving based on reported developments in the Iran war. Signs of de-escalation are seeing oil prices and interest rates decline, while signs of escalation are having the opposite impact.
• So far, equities have remained focused on strong corporate earnings growth despite the war. As long as the probable war impact on growth remains limited in scope and duration, equities seem willing to look over the valley. If there is a positive resolution, then near-term leadership may shift, and market breadth may increase.
• Our investment strategy remains unchanged. Asset allocation remains modestly pro-risk but focused on quality and structural growth.

Was there any major macro-economic or geopolitical news last week?

• Flash Purchasing Manager Indices (PMIs) for May were released last week. European data was weaker than anticipated and suggests an accelerating decline in economic activity, particularly in services. European manufacturing slowed but still showed growth. On the other hand, the US economy showed stable growth. Services activity unexpectedly slowed but remains in expansion. The US manufacturing PMI suggests accelerating growth, albeit some of this may be pre-emptive. In both regions the Iran war has led to sharp increases in energy/input cost pressures and supply chain disruptions.
• The minutes of the most recent FOMC meeting were released last week and showed a more hawkish tone given the inflationary impacts of the Iran war/oil prices and tariffs/supply chain disruptions. More Fed governors than expected supported a shift in language to a more balanced outlook from an easing bias. The shift is broadly consistent with market expectations.
• Russian President Putin travelled to Beijing to meet with Chinese President Xi last week. While there were cordial statements, like US President Trump’s recent visit to China, there seems to be a lack of major announcements.

The week ahead: what to watch out for

There are market holidays in several European countries and the US today. Euro area economic confidence surveys are due to be released Thursday. US Q1 GDP revisions are due on Thursday. No changes from initial estimates are expected. The Personal Consumption Expenditure Deflator, i.e. the Fed’s preferred measure of inflation is also due out on Thursday. Expectations are that headline month-on-month (m/m) inflation will have fallen to 0.5% from 0.66%, but the core deflator is expected to be stable at 0.3% m/m.