Fury in February

There was much to be optimistic about for global multi-asset investors in February as several stock markets made further gains. However, escalating tensions in the Middle East throughout the month was followed by military action between the US, Israel and Iran at the end of the month and brought more volatility for investors. The US stock market underperformed other regions in February but safe-haven demand for the US dollar helped Sterling investors. Gold, broad commodities and bonds also contributed to portfolio returns.

Escalating tensions in the Middle East were clear throughout February as the Americans built up military presence to pressure Iran into a nuclear deal. Talks on Tehran’s nuclear programme ended without a deal, however, and the US and Israel launched major combat operations on 28^th February with airstrikes across Iran. They argue that Iran is developing missiles that could threaten the rest of the world. Iran’s Supreme Leader died in the attacks, alongside hundreds of other casualties, and Trump has called on the Iranian people to take over the government. Iran has retaliated with strikes across the Middle East in the UAE, Qatar, Bahrain, Jordan and Kuwait – all home to US military bases. The UK has agreed for the US to use British military bases while there has been a drone strike on a British base in Cyprus. At the time of writing, the conflict is ongoing with President Trump stating that Iran strikes will continue until the goal of eliminating imminent threats from the Iranian regime have been achieved with Iranian nuclear and military capabilities destroyed.

From an investor perspective, key questions are how long the conflict will last and the status of shipping via the Strait of Hormuz. The strait is a narrow passage that leads from the Persian Gulf into the Gulf of Oman and onto the Arabian Sea and the Indian Ocean. It is hugely strategically important for global trade because around a fifth of global oil supply, around 21 million barrels a day, moves through the Strait of Hormuz. Ships travelling through purchase war-risk insurance which protects from the cost of being attacked. War-risk premiums sky-rocketed over the weekend, effectively closing the Strait of Hormuz and causing oil prices to spike. The longer the conflict lasts, the larger and more persistent the spike in oil prices will be. Strategists have estimated that blocking the strait could push oil above $100 and inflation could rise around 0.3%-0.5% for every 10% increase in oil prices.  If temporary, central banks are likely to look through, but persistently higher prices make it more likely that combative action will be taken by raising interest rates. Higher oil prices and interest rates are both likely to weigh on economic growth.

Historically, Trump has typically favoured swift military operations and one of his key priorities is to tackle inflation. Therefore, it seems likely that this is the intention. Furthermore, there will be pressure from the UAE, Qatar, and other regions who are being attacked, who have leverage on Trump through investment flows and sovereign allocations, to resolve the situation quickly.

Asset markets have reacted in a typical risk-off fashion to the events unfolding. Gold, energy and other commodities as well as the US dollar have gained significantly. Inflationary pressures from higher energy prices and supply chain disruptions are negative for the stock market and, as such, stocks have declined. UK stocks are a relative winner with the large-cap index tilted towards energy companies, materials and consumer staples. UK investors in US stocks will benefit from a stronger dollar but emerging market stocks, which have performed very well over recent months, are likely to suffer if US dollar strength persists because their dollar-denominated debt will become more expensive to repay.

Bottom Line

It is likely that any indication of military action ending will see a rapid reversal of geopolitical risk premiums. However, with so many unknowns, near-term volatility may persist. It is at times like this that we are reminded of the importance of building multi-asset portfolios with resilience. Strategic allocations to gold, broad commodities and UK stocks will help our portfolios weather the current situation.

Noteworthy

What’s happening in the US stock market?

US stock market indices have been rangebound over recent months, but volatility has been evident at a sector and stock level. Technology stocks have underperformed so much that valuation multiples for some of the biggest companies in the sector are now at their lowest level in years. Fears have emerged in a couple of areas. Firstly, there are concerns that AI capital expenditure (capex) plans are excessive and may not bear fruit. Amazon’s stock fell around 10% in early February after the company’s forecast of $200 billion capex in 2026 vastly exceeded Wall Street expectations. Secondly, recent AI developments are so impressive that the viability of software firms is being challenged. The chart below illustrates the recent underperformance of the US software sector. Investors are worried that AI agents, such as Claude Cowork, will be capable of automating complex tasks across multiple professions at low cost. The share price for Infosys, a giant software and IT services company, dropped around 20% in February. These AI developments have also had implications beyond listed stocks. Investor enthusiasm for private credit lending companies which are exposed to the troubled software sector has dropped. Blue Owl, a firm that specialises in private lending, shut a private credit fund as they focused on selling assets to meet investor withdrawals. KKR, an American global private equity company, shares fell sharply after they reported asset markdowns tied to software exposures and a 31% dividend cut. While this all sounds dramatic, other sectors have gained and kept aggregate US stock market indices close to all-time highs. Energy companies, for example, have benefitted from higher oil prices while investors also flocked to industrials, which are harder to disrupt, and consumer staples.