ClockWise: Iran conflict calls for broad diversification and active management

The United States and Israel have embarked on a war with Iran which could develop into a wider regional conflict. Energy prices surged after the Strait of Hormuz was closed to shipping and Qatar ceased production of liquified natural gas..

Stocks have sold off from near all-time highs, with energy importers in Europe and Asia hardest hit. A lack of clear war aims and the unpredictability of the political situation both in the US and within Iran make it hard to judge whether this is the start of a short-lived conflict or a more prolonged period of uncertainty. At times like this we believe that broad diversification and active management are more important than ever.

A lack of clear war aims and the unpredictability of the political situation both in the US and within Iran make it hard to judge whether this is the start of a short-lived conflict or a more prolonged period of uncertainty.

We have argued that the world has become more inflation-prone since the pandemic with tight commodity supply, deglobalisation, high debt levels and geopolitical risk likely to trigger sudden price level shocks. In our view, this new era of 1970s-style ‘Spikeflation’ (figure 1) favours our more broadly diversified approach to strategic asset allocation. Royal London is one of the UK’s largest commodity investors[1]. Commodities provide a real time hedge against unexpected inflation. Commercial property also plays an important diversifying role as an alternative growth engine to equities with performance linked to the domestic economy rather than international events. Within equities, our exposure is tilted towards the UK, a reasonably valued, inflation-resilient and defensive market.

Figure 1: Drivers of Spikeflation

Active management allows us to anticipate and respond to events. The Investment Clock model that guides our asset allocation is in the disinflationary Recovery phase of the business cycle (figure 2). We have been tactically overweight equities on strong tech-driven earnings and expectations of a pick-up in global growth as the interest rate cuts of the last year take effect. A Middle East war and oil shock has the power to change this positive backdrop, however, and we have reduced exposure given increased uncertainty on the economic outlook. We’ve been overweight commodities, including gold, as a hedge against rising geopolitical risk, and this has helped to mitigate losses in recent days.

Figure 2: Investment Clock in equity-friendly Recovery

Source: RLAM. Trail shows monthly readings based on global growth and inflation indicators. The yellow dot is the current reading.

The outlook for the world economy and financial markets will depend on how long hostilities and the pressure on energy prices lasts.

• President Trump’s stated preference is to ‘do a Venezuela’, making a deal with new and more compliant leadership within Iran, while keeping the regime in place. This would involve a commitment to cease the nuclear programme, to give up ballistic missile capability and to stop funding regional proxies that pose a threat to the State of Israel. In this scenario, the Straits would re-open, oil prices would drop and stocks would rebound with little lasting damage. We see this outcome as possible but increasingly unlikely as events unfold.
• Our base case is more prolonged conflict and/or instability within Iran and the Middle East, with high energy prices impacting the global business cycle. Rising inflation could move the Investment Clock from Recovery into commodity-friendly Overheat, reducing the scope for interest rate cuts and keeping stock markets volatile, as we saw in 2022 after Russia invaded Ukraine (figure 3). This scenario would see bond yields rise.

Figure 3: Russia invades Ukraine (2022)

• A worst case scenario could see global recession fears emerge in a repeat of Gulf War dynamics, with the region in chaos for months if not years, and energy prices moving to a significantly higher trading range. Crude oil spiked dramatically in August 1990 when Iraq invaded Kuwait, with recession fears depressing stock markets until a US-led coalition liberated Kuwait six months later (figure 4).

Figure 4: Iraq invades Kuwait (1990)

The 2026 attack on Iran came with US equity valuations at their highest level since the dot com boom and stocks near all-time highs (figure 5), so the downside under one of the more negative scenarios could be significant. It’s also not clear that there will be an obvious end to the current conflict given a lack of clarity around war aims and the risk of an ongoing cycle of reprisals.

Figure 5: US and Israel strike Iran (2026)

These are uncertain times. As we like to say, there is no such thing as passive in multi asset. The choice of asset classes you include in a portfolio should be an open question. We favour broad diversification with inflation hedges to increase resilience to shocks and with a flexible and active tactical approach that can adjust exposures as conditions change.

1. Top 20 Fund of Funds Teams

For professional investors only.  This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.