Looking through the crisis: Asset Allocation Committee views

At the time of writing, the Trump administration has extended a deadline for Tehran to reopen the Strait of Hormuz. Negotiations and military contingencies are running in parallel. Markets are struggling to price this geopolitical shock, which is already visible in energy markets but not yet in gross domestic product (GDP) data—or, arguably, in equity valuations.

The situation is highly uncertain.

I’m not a geopolitical expert, and I don’t play one on TV. When discussing these events in a recent CNBC appearance, I said that the range of outcomes for markets is wide.

I recognize these statements may sound like an out.

But it’s equally true that there is no historical precedent for this level of oil, LNG, and fertilizer supply disruption. The situation requires judgment calls on the part of asset allocators.

How we’re managing this environment

The war in the Middle East was top of mind as we, the Asset Allocation Committee (AAC), discussed tactical positioning at our latest meeting.

The outcome? We elected to maintain the broad positioning themes we had in place before the war:

• Neutral between stocks and bonds
• Diversified in our equity exposure with a “broadening” bias (overweight small-caps and international equities, for example)
• Short in our duration stance
• Diversified in our risk hedges (including an overweight to real asset equities to help mitigate against inflation)

We’re attempting to look through near-term market volatility. Stocks have been relatively resilient for good reasons. Fiscal stimulus continues to flow, higher-end consumers are still spending, artificial intelligence capital expenditure (AI capex) has accelerated, and corporate earnings remain strong. We believe these trends will endure beyond the conflict, and we remain positioned for market broadening that will likely follow as conditions stabilize.

Increasing our inflation hedge

While reaffirming our tactical positioning, we elected to increase explicit inflation hedging through inflation-protected bonds. Beyond oil, fertilizer markets are also on our radar; the conflict poses serious upside risks to food prices and broader inflation.

Curiously, market-based inflation expectations have not moved meaningfully. As one committee member put it:

“No one has an edge on how long the war will last… How do we make money? Long-term inflation expectations are unchanged… So, adding inflation protection looks like a layup. Unless there’s a massive recession, CPI prints could be large.”

How we’re thinking through the oil shock

We are watching a macroeconomic chain reaction: geopolitics → oil prices → inflation → higher rates → growth scare. The committee’s judgment is that we are early in that sequence and that markets may be underestimating both the damage already done and the potential length of the conflict. Several energy analysts on our platform share this view.

Ultimately, two realities anchored our positioning:

1. This, too, shall pass. There are active mediation efforts to wind down the conflict, and the economic pressures are intense. As our Head of Global Fixed Income and CIO, Arif Husain, wrote recently, “The incentives for all parties favor a conclusion sooner rather than later. Whether compelled by concerns around logistics, human, economic, or political costs, the odds are stacked toward de-escalation.”¹
   
   The consensus reaction is often to fade geopolitical events. That's probably right in the end. Based on seven geopolitical-driven oil shocks since the 1990s—including those at the onsets of the Gulf War, the Iraq War, and the Russia-Ukraine War—the median timespan from the inciting event to the oil price peak was 28 trading days, with an average oil price  rally of 27%.² After 25 days of the current conflict, oil was up 40%.³
   
   
2. It could take longer than expected. The committee kept returning to the same hard truth: there is no reliable playbook for a modern, large-scale disruption of a chokepoint that handles a meaningful share of global oil, liquefied natural gas, and fertilizer trade.
   
   Polymarket data imply a 32%⁴ chance that shipping traffic through the strait will return to normal by the end of April. The oil price curve seems to agree with that potential outcome. Other prediction data, such as those from the professional forecasters at Good Judgment, seem less optimistic.
   
   Our analysts aren’t ruling out a scenario in which oil spikes above $150 per barrel, although they see this as a lower probability event. Even if a deal gains traction soon, it may take weeks for the sides to reach an agreement and implement an unwinding of the blockade. The clock is ticking on a more benign resolution.

Resilience

Going back to early 2022, we’ve witnessed Russia’s invasion of Ukraine, 9% inflation, 550 basis points of U. S. Federal Reserve rate hikes, the second, third, and fourth biggest bank failures on record, historic increases in tariff rates, and a war in the Middle East. Yet over that period, stocks were up more than 50%.⁵

Equity resilience has been generated by strong earnings, AI capex, and addictive levels of fiscal stimulus.

Rewinding even further, history tells us that stocks have typically fared well in the wake of geopolitical turmoil. Looking at 14 major geopolitical events over the last 64 years, the average forward 12-month return for the S&P 500 was 9.5%, with a hit rate of 10 out of 14.⁶

We continue to favor global small-caps. Recent trading action shows that when headlines surrounding the war turned positive (e.g., talks about a deal), small-caps outperformed, as did international equities.

Small-caps look poised to benefit from a valuation advantage and policy that favors domestic growth (a lot of fiscal measures support smaller companies). Plus, if earnings growth converges, as we expect, so should valuations.

Where could we be wrong?

Obviously, the conflict could continue to escalate, prolonging supply disruptions and raising the odds of stagflation. Even if the Strait of Hormuz reopens under more benign conditions, oil prices are unlikely to return to pre-war levels.

Priyal Maniar, one of our co-portfolio managers who specializes in natural resources, emphasizes that fundamentals were already pointing to higher prices before the conflict, as additional production will be needed to meet demand and offset natural declines from maturing U.S. shale.⁷ This poses a risk to economic growth prospects.

We’re also mindful that U.S. equity valuations leave little room for error. Consider that the S&P 500 Index’s dividend yield is roughly the same as it was during the internet bubble and that its price-to-sales, price-to-book, and price-to-cash flow ratios are above dot-com era levels.⁸

As one member noted: “Risk assets are expensive, and that makes the distribution asymmetric if inflation reaccelerates and policy must stay tight.”

Private credit is another area we’re monitoring. There are probably losses yet to be realized in low-quality portfolios, but we don’t see this as a systemic risk. Compared with 2008, there’s less leverage and concentration.

The bottom line

Heading into the war, the AAC was long the broadening trade, positioned for higher inflation, and neutral on stocks versus bonds. We maintain those positions.

The committee’s base case remains that markets will eventually look through the conflict. However, we can’t predict the timing. What matters most is not debating the unknowable (“how long will it last?”) but assessing what has already been damaged.

Inflation risk is the clearest transmission channel—and the one markets may still be underpricing.