Market watch: Geopolitical shock and the long view

AN EXTREMELY EVENTFUL QUARTER

The outbreak of conflict in the Middle East overshadowed all other developments during the first quarter and has had a significant impact on the global economy.

Other significant events included the US capture of Venezuelan president Nicolás Maduro, White House threats regarding Greenland, and the US Supreme Court ruling against the Trump Liberation Day tariffs. All have largely been forgotten in the wake of the conflict.

IMPACT ON THE GLOBAL ECONOMY AND FINANCIAL MARKETS   

As one might have expected, the oil price jumped to over $100 per barrel. Fertiliser and gas prices also soared. Air and sea travel around the Middle East has been severely disrupted, and central banks have had to review their expected monetary policies. It is too early to say with confidence what central banks will do, but I think it is safe to argue that rate-cutting plans will have been put on ice for now. 

The threat of a global recession has certainly increased, and if central banks react by hiking interest rates in the wake of higher inflation, a stagflationary environment, with negative implications for stock markets, may materialise. At this stage, our view is that central banks will hold off on rate hikes, but the chances of policy errors are still high.

The first quarter was tough for investors. The US dollar, which had been on a depreciating trend, firmed against most currencies given that it is still seen as a safe-haven currency in turbulent times. The gold price, which peaked at $5 500 an ounce, fell sharply to a low of $4 200 and has since recovered to around $4 600. Stock markets around the world declined, and bond yields rose.

The rand depreciated by 2% against the US dollar, which, to a degree, cushioned the fall of global financial assets when viewed in rand terms. Hard-running gold and platinum shares were the biggest victims of the turmoil on the JSE, with the resources sector declining by 15% during March – but it is still up for the year to date, and up by 91% over the past year.  

HOW LONG WILL THE CONFLICT LAST?

This is the key question for investors. The pressure to end the conflict and restore some normality in energy markets is immense – for the US ahead of mid-term elections and for energy consumers everywhere.

It has now been over a month since the start of the conflict. The Iranian army, navy and air force have been materially weakened. Yet, Iran retains drone and missile capability and its grip on the Strait of Hormuz has been the defining economic lever of the conflict.

A key unexpected spillover was the spread of attacks to the Gulf states and the virtual closure of their major airport hubs, with meaningful consequences for those economies.

At the time of writing, the US and Iran had just agreed a two-week ceasefire, brokered by Pakistan, with Iran committing to reopen the Strait of Hormuz. The oil price fell sharply on the news. The ceasefire buys time to negotiate a longer agreement, but much remains to be resolved. How the situation develops from here will determine whether this is the beginning of the end or merely a pause.

OUR FUNDS’ POSITIONING NOW AND LOOKING FORWARD

Our multi-asset funds have a high global equity weighting – we are close to the full 45% offshore allowance – and the SA equity portion has high exposure to global businesses. The strong rand over the past year was a headwind for this positioning, while the rand weakness in March worked in our favour. However, our equity selection in both developed and emerging markets detracted from performance over the period. We remain negative regarding the outlook for global bonds, especially sovereign debt, given our concerns over the high levels of government debt.   

In the domestic portion of the portfolio, we have been significantly underweight gold shares compared to the index for some time. This is a stance that has hurt for the past year, but the sharp sell-off in gold shares in March benefited our positioning. The South African economy remains stuck in a low-growth phase, and careful stockpicking is required. In our view, even in this sluggish economy, the best management teams come to the fore and find ways to grow their profits. It is our task as asset managers to identify these winners and avoid the losers.

In the bond space, we increased our exposure to inflation-linked bonds as inflation dropped to very low levels. While the timing and nature of geopolitical shocks, such as the current conflict and its impact on the oil price, are inherently uncertain, we own inflation-linked bonds precisely because they offer our portfolios some protection when unexpected events like this occur. 

Asset managers cannot predict with certainty short-term events, such as how long this conflict and the disruption to energy prices will last. History has shown, however, that when crises pass, markets tend to recover swiftly, leaving those with high cash holdings looking on. Our long-term approach is focused on finding winning businesses and staying invested through difficult times. This strategy has worked over many decades, and we see no reason to change.

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