Why it’s not 2022 all over again

This note contains an overview of our market views, what we are watching, and our portfolio strategy. Any reference to portfolio positioning relates to our Flagship Solution. Clients with bespoke discretionary or advisory portfolios should consult their Client Advisor for the latest update on your portfolio.

When history rhymes and when it doesn’t

The conflict between the US/Israel and Iran inevitably draws comparisons to early 2022, when Russia invaded Ukraine and markets sold off sharply. Back then, the trigger was an inflation and interest rate spike driven by monetary and fiscal stimulus, supply-chain strains and booming demand once the economy reopened after the pandemic lockdowns. Now, oil price increases are leading to renewed inflation concerns, but the economic backdrop is different.

Start with energy. In 2022, the world was hit by a war at the borders of Europe at a moment when inflation was already running hot in the post-Covid world, with supply chains, from shipping and aviation to manufacturing, all significantly disrupted and facing severe labour shortages as well. Inflation was well above central bank targets, 9% in the US and 10-11% in the Eurozone and the UK. The continent remained deeply dependent on Russian gas (around 40% of its imports pre-war). When those flows were disrupted, prices surged, inflation expectations jumped, and central banks were forced into aggressive rate hikes, from a starting point of negative interest rates in the Eurozone and near-zero in the US and the UK.

Today’s setup is less fragile. Europe’s energy mix has shifted dramatically, with Russian gas now a sliver of total imports (less than 10%). Natural gas from the US, Norway and Qatar, along with renewables, has filled the gap, and storage is at a higher level. The US is a net exporter of energy. Even if energy prices rise, the feedthrough into broad inflation looks more contained, helped by the fact that policy rates are now higher than in 2022, consumer and labour markets no longer overheated. Supply chains are functioning much better across manufacturing and have become more flexible.

In 2026, the chokepoint is the Strait of Hormuz, through which roughly 20% of global oil flows. Taken alone, that number can be misleading. Most of that oil goes to Asia, not Europe or the US. Even if China takes a large share, with around 40-50% of its imports passing through the strait, its energy system is heavily diversified: coal still makes up about 55% of its primary energy consumption, oil closer to 20%, with the rest split across natural gas, hydro, nuclear and renewables. It also holds sizeable strategic reserves. So, while a disruption would matter for global importers, it wouldn’t trigger the kind of systemic scramble Europe faced two years ago.

Why preparing for different scenarios matters

Investors can’t predict how the conflict will evolve, given the many paths it could take. However, what we can do is stress-test our 2026 baseline scenario. In a scenario where the conflict stays contained within three months, with risks of spilling into another quarter, the growth and inflation hit looks relatively moderate – still positive but lower growth, higher inflation for some time but not spiralling to the levels seen three and a half years ago. Energy importers are also less exposed than in 2022, helped by a weaker dollar that softens the blow of higher commodity prices.

Given this macro setup, the policy response looks more straightforward, too. Central banks seem to agree. The US Federal Reserve (Fed), the European Central Bank, and the Bank of England all left rates unchanged last week. Raising rates won’t reopen the Strait of Hormuz or bring oil prices down. The initial reaction to the rise in oil prices could be higher inflation, but dearer oil bills also weigh on household finances, overall growth and inflation. Central banks may overlook this supply shock and keep policy rates steady to not hinder demand growth. Fed Chair Powell made this point last week. Unlike in 2022, there is no immediate need for aggressive tightening or emergency fiscal intervention, provided the conflict does not broaden materially. 

How we’re positioned

Our portfolios reflect this backdrop. We don’t react to every headline. We continue to look for opportunities to diversify our exposures and mitigate risks. We bought more gold and dollars at the start of the conflict and sold US Treasuries and UK gilts, which are more vulnerable to inflation. We shifted to higher-quality fixed income at the start of the year, maintaining other inflation hedges such as commodities and inflation-linked bonds. Exposure to emerging market bonds adds another layer of diversification as they include non-Middle Eastern commodity exporters, which could benefit from these oil and supply disruptions.

Given the Iran conflict, we also kept equity downside protection where regulation and client expertise permit. With the recent bout of volatility our ‘insurance’ warrant has risen in value, recouping the initial investment, so we locked in that gain and kept the rest in place until June as protection to mitigate downside risks should volatility persist.

Still, risks remain. Markets may be underestimating the odds of a prolonged conflict or a meaningful disruption to the Strait of Hormuz if Iran escalates, even if its military capacity has taken a hit. The conflict involves many parties with different goals, which makes the outlook harder to map.

A further risk, which could result in a shorter-than-expected conflict, and hence a market rally, comes from US politics. Congress still needs to approve additional funding to prolong US military operations in Iran, and that isn’t guaranteed. Additional spending on the Iran war will require 60 votes in the Senate, not just 50, meaning the White House will likely need at least eight Democrats, assuming Republicans are all united in favour, which we do not think they are. And then, there are the midterms. There may be limited incentive to sustain a prolonged conflict. Trump’s approval ratings are falling as gas and groceries are top of mind for consumers, and Congress could turn Democratic. A long conflict could cost the current Administration more at home than abroad, which might be a strong disincentive to prolonged military actions.

The situation, geopolitically, is serious, but the economic environment today is sturdier than in 2022. As a starting point, growth is healthier, inflation lower and the world is less vulnerable to an energy shock. That backdrop helps explain why many markets, apart from European and emerging market equities, have been more resilient so far than in past episodes of oil price increases. They’re down, but not so much. It also reinforces why diversification and risk mitigation remain essential – and why we’ve built portfolios with exactly that in mind.

This week | Middle East, economic growth and inflation in focus

This week shifts the spotlight from central bank meetings to the data once again. What’s coming could give us the first real read on how the Middle East conflict is spilling into economic activity. The first signals arrive with the preliminary purchasing managers’ indices (PMIs) for March (Tuesday). These should start to show where momentum is slipping.

Germany’s Ifo Business Climate survey follows (Wednesday) and will offer a more grounded look at how firms are responding. The UK numbers are a bit different. February inflation and producer prices (Wednesday) predate the conflict, so they probably won’t reflect much. We’ll also get UK retail sales on Friday, again for February, so the picture there will stay relatively calm.

The real focus will be on the March data, the next round to be released in a few weeks, from mid-April. That’s where markets expect the first clear impact of the Iran conflict, especially through energy prices. And energy is likely to stay at the centre of the conversation for a while.

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