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Executive Summary
Market review
Q1 saw a shift from orderly rotation to a broader risk-off environment, with rising equity-bond correlation challenging traditional diversification. The US–Iran conflict triggered an energy shock, pushing oil sharply higher and forcing central banks to pause rate cuts as inflation risks reemerged. The S&P 500 declined 4.4%, while the Nasdaq fell more than 10% from its all-time high. In contrast, broad commodities surged 23.3%, driven by the sharp spike in oil prices. As markets tend to price ahead of outcomes, any signs of de-escalation could drive a relief rally. Portfolio positioning remains balanced, with better diversification through alternatives.
Fog of war
Amid the ‘fog of war’, investors have only partial visibility – while the conflict is ongoing, the path and market implications remain highly uncertain. Conflicting messaging from decision makers means that markets are reacting less predictably, with headline-driven rallies (and the infamous TACO trade) fading more quickly. Oil prices are one indicator of how the conflict is evolving, with sustained moves higher raising inflation and recession risks, while a move lower signaling de-escalation. A contained conflict remains the base case, with political pressure building for de-escalation. But uncertainty remains high and requires resilient portfolio positioning.
Focusing on fundamentals amid the fog
Global economic activity was strengthening prior to the conflict, with both services and manufacturing showing improvements. Corporate profits remain resilient, supported by AIdriven productivity, strong balance sheets, and steady consumer demand. Equity valuations have moderated, driven by both price declines and continued earnings growth, improving the entry point for long-term investors. Geopolitical shocks have historically had limited and short-lived impacts on markets. If the current conflict is resolved within a reasonable timeframe (before causing lasting economic damage), the ingredients for a resumption of the bull market appear to remain in place.
Fixed income amid uncertainties
The broad income-driven gains of 2025 have given way to a more challenging environment, where yield (income) maximizing is no longer rewarded. Rising inflation risks and a repricing of term premia have increased volatility in long-duration assets, making active duration and credit selection critical. Positioning for stability: Focus on the shorter-end (e.g. 3–5 year segment) of the curve to balance income and volatility, alongside a preference for higher-quality investment grade. Diversification beyond traditional income: with equity–bond correlations less reliable, alternative income sources such as catastrophe bonds provide valuable uncorrelated returns and portfolio stability.
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