Reviewing previous market commentaries can be a humbling experience, with markets and events moving quickly even in normal times and new events often appearing from left field. However, one theme that almost all commentators have consistently called correctly is the unpredictability of Trump, although perhaps underestimating the scale of capitulation, conflicting narrative, and conflicts of interests.
Conflict is perhaps the most fitting word to describe the start of Trump’s second term – the notable exception relative to the first term being conflict within his own camp, where most policies and statements are met with support or silence. His 2024 election campaign was defined by two main themes: a war on prices and a 24-hour resolution of the war in Ukraine. In reality, conflicts have raged on in Ukraine, tensions in Israel/Palestine remain unresolved, there have been threats to take Greenland, and Trump has launched his own attacks – the first on his own population through the deployment of ICE across US cities and then, of course, the joint attack on Iran with Israel which has resulted in fresh inflation concerns across the world.
Any of these events warrant analysis, however, the war in Iran has had the most immediate impact on markets. The initial consequence has been heightened volatility and most asset classes giving back recent gains. This is largely driven by higher energy prices which increases the risk of stagflation – rising inflation and falling growth. In response, markets have reassessed the likelihood of interest rate cuts, resulting in a re-pricing of most asset classes, similar to the experience of 2022/23.
The underlying drivers of inflation today, however, differ meaningfully from that earlier period. In 2022, price rises were primarily driven by a post-Covid surge of spending, a result of extremely high levels of liquidity pumped into the system through government expenditure and very low borrowing costs. In other words, it was demand driven. The position now is different. Demand is tame across most of the world, with the interest rate hikes of 2022/23 incentivising savings over spending and reducing the attractiveness of borrowing. The cause of future inflation, would, therefore, not be demand driven, but a reduction in supply predominantly due to a rise in energy prices.
Whilst the cause of inflation does not change how higher prices affect consumers; there is an important distinction for markets. The main tool Central Banks can use to manage inflation is adjusting interest rates, which is effective at managing demand but not supply. This means that it was an appropriate measure to cool the post-pandemic surge in spending but will have little influence on the flow of oil through the Strait of Hormuz. Instead, rate hikes will risk exacerbating the stagflationary pressures they are trying to avoid. With this in mind, we believe the chances of significant rate hikes to combat the potential inflationary spike this war may cause are currently reasonably low. However, the likelihood that interest rates will be used to a significant extent is a technical, but important factor that we must consider when constructing portfolios and managing risk.
Another key factor we need to consider is the likelihood of US de-escalation in the Middle East. Recent history suggests that declaring a post hoc ‘goal’ achieved and the mission complete is a favourite of Trump’s playbook. Whilst timing is uncertain, upcoming domestic priorities, including hosting the World Cup and mid-term elections, may incentivise an attention shift towards a more constructive narrative to deliver to his voters. A de-escalation that contributes to lower energy prices would align closely with Trump’s political objectives, particularly given the visibility of fuel prices to voters. Should this occur, we would expect many of the recent market moves to reverse as inflation expectations ease.
A meaningful resolution will ultimately depend on cooperation between Iran and Israel, particularly regarding the flow of oil through the Strait of Hormuz. Iran’s ability to sustain a full blockade may already be constrained, but a fragmented leadership structure can increase the risk of unexpected flare ups and continued volatility. From a humanitarian perspective, a lasting resolution should be the objective, though likely to take time. From a market perspective, however, the immediate focus remains firmly on energy supply dynamics.
Although the timing of a return to normal oil flows is uncertain, supply-side shocks of this nature are typically temporary. When energy flows do show signs of normalisation, market recoveries can occur quickly. Provided the disruption does not persist for an extended period, a normalisation of supply would not require a significant rebound in global demand to support asset prices. This would bring us back to an environment similar to that seen at the start of the year – one that is broadly supportive of both equities and bonds.
With this in mind, our approach remains measured but constructive. We continue to favour staying invested, with a bias toward high quality companies, bonds, and real assets – areas that tend to be more resilient in periods of slower growth while remaining well positioned for recovery when sentiment improves. As we have maintained a cautious stance around concentration and valuation levels in parts of the US market we have been actively diversifying geographically, which we still believe is the most sensible way to manage risk during periods of uncertainty.
For long-term investors, the risk of exiting markets and missing the eventual recovery is, in our view, greater than the risk of remaining invested through periods of short-term volatility. History has repeatedly shown that market downturns are often followed by sharp recoveries, frequently triggered by improvements in sentiment rather than fully realised outcomes. Accurately timing these turning points by trading into and out of the market throughout unpredictable events is exceptionally difficult. Markets tend to adjust rapidly to positive developments, leaving those on the sidelines with limited opportunity to re-enter at attractive levels.
Whilst the current environment may feel frustrating, it reinforces a fundamental principle of investing: that time in the market is typically more valuable than timing the market. A well-constructed portfolio, aligned with a long-term investment horizon, allows investors to navigate short-term uncertainty without the need to predict inherently unpredictable events. This strategy of maintaining discipline and focusing on long-term objectives, allows investors to continue to benefit from the compounding of returns and the resilience that markets have consistently demonstrated over the long term without risking permanent losses through trading into and out of the market throughout unpredictable events.
This note is intended as a general market update and should not be regarded as specific advice or treated as a recommendation to invest in any particular fund or asset class. Stock market investments can fall as well as rise. If you would like to discuss the implications for your own portfolio, please do get in touch.