The conflict in the Middle East has shifted from being perceived as something temporary, calculated, and priced in to being seen as a conflict with greater duration and impact on the energy market. Investor sentiment is changing, as reflected in Bank of America’s global fund manager survey for March. Its results show an increase in liquidity, but without a decline in equities despite concerns about Iran.
The main conclusion is that the conflict and developments in private credit are putting an end to the excessive optimism of recent months in the fund market. According to the Investment Strategist team at BofA, led by Michael Hartnett, “the fund market in March is bearish enough to sell oil above $100/barrel, sell DXY above 100, buy GT30 at 5%, and buy SPX at 6600.” However, they believe positioning is far from the extremely bearish levels seen at recent lows in risk assets.
Optimism and risks
According to the survey, optimism about global growth falls to a net 7% from 39%, inflation expectations rise to a net 45% from 9%, and optimism about rate cuts is at its lowest since February 2023. “But no one is considering a recession; the probability of a hard landing is just 5%, compared to 46% expecting no landing and 44% expecting a soft landing,” BofA notes.
In the view of Diego Franzin, head of portfolio strategies at Plenisfer Investments, part of Generali Investments, in the short term market developments will continue to depend mainly on news related to the conflict with Iran. “Interest rate developments already reflect expectations of a renewed rise in inflation and a possible response from central banks, as policymakers remain very aware of the monetary policy mistake made in 2022, when they waited too long to raise rates after inflation began to accelerate,” he notes.
However, the Plenisfer Investments expert warns that the macroeconomic backdrop differs significantly from that of 2022: “Growth momentum is weaker, fiscal capacity is significantly more limited in most developed economies, and the initial levels of both interest rates and inflation are different.”
In terms of risks, in March geopolitics and inflation replaced the AI bubble as the main tail risks. Notably, 63% say private capital/credit is the most likely source of a systemic credit event, making clear which other market investors are watching.
Implications for the investor
This sentiment and market outlook in March has translated into a rotation of positions, moving from booming sectors, such as banks, to stagflation sectors, such as consumer staples. “In general terms, covering of short positions in the US dollar has been moderate, investors maintain long positions in commodities (most since April 2022) and retain large overweight positions in equities, especially in emerging markets (most since February 2021), Japan (most since May 2024), banks, and industry, in sharp contrast to a significant short position in consumer discretionary stocks (the largest underweight since December 2022),” explain BofA.
For Franzin, risk assets still appear to be pricing in, to some extent, a relatively benign scenario. “The prevailing view among equity investors remains that the conflict will be short-lived and will have limited economic repercussions. In our view, however, the potential repercussions of the conflict come at a time when the global economy is already facing a number of structural vulnerabilities, increasing the risk of a stagflation scenario. In this context, assets that have been penalized mainly by positioning dynamics—among them some emerging markets such as Brazil—could be among the first to outperform once the flow of news begins to stabilize,” he notes.
From the perspective of Yves Bonzon, Chief Investment Officer (CIO) of Julius Baer, the current market correction offers an opportunity to initiate or increase exposure to asset classes supported by structural trends. “Emerging market bonds denominated in local currencies and Chinese equities stand out, including those linked to AI. Chinese equities benefit from continued signaling from Beijing in favor of a controlled and sustained equity bull market, implying government intervention to mitigate disruptions and volatility. In addition, China remains the only market offering investors exposure to AI outside the US, with the added advantage of developing the technology in a notably capital-efficient way,” Bonzon argues.
Asset performance
According to Benoit Anne, Senior Managing Director and head of the Investment Solutions Group at MFS Investment Management, it is particularly interesting to analyze the performance of different asset classes since the start of the war with Iran. His analysis points to a significant shortage of defensive assets.
“Clearly, the price of oil has been the standout winner, rising more than 40% since the start of the crisis; and the US dollar has also increased, although more modestly. By contrast, gold, which had been a market star for some time, has declined by more than 5.5% since the start of the conflict. Duration has also performed poorly, with the UST index and the Bund index falling by around 2%, mainly due to upward pressure on government bond yields. Looking ahead, we face a highly volatile environment given the extreme level of geopolitical uncertainty,” he summarizes regarding the performance of the main market assets.
In his view, although the DXY index has risen by around 2.6% during this period, a sharp reversal in recent movements cannot be ruled out, although this will depend on the duration of the geopolitical crisis. “In this context, the price of oil has become the most important barometer of global markets. Only a couple of currencies have managed to appreciate against the dollar in the past two weeks, including the Colombian peso and, to a lesser extent, the Israeli shekel. All other major asset classes have declined, some quite significantly. Emerging market equities, eurozone equities, and emerging market local currency debt rank at the bottom of that list,” Anne concludes.
By Funds Society