It is hard to have strong conviction in the fog of war. While most will tell you to look through geopolitical events, the spike in the oil price and the energy supply constraints will have an impact on the economy and thus asset prices. While no-one can predict the outcome of the war, the longer the Straits of Hormuz remain shut, and as long as the conflict includes targeting energy infrastructure, the more of an impact will be felt across the world.
Closing the Strait removes 20mb/d of supply, which is around 20% of global demand. While there are offsetting factors, such as the Saudi pipeline which can divert around 8mb/d from the Strait to the Red Sea, countries tapping their strategic petroleum reserves, and certain ships being allowed through the Strait at this time, there is still a huge mismatch. For reference, when the world economy shut in 2020, oil demand fell by 10mb/d.
The US is perhaps most insulated from these events, given their domestic energy supply and limited reliance on the Strait, but regions like Asia and Europe, as well as specific countries like South Africa given it is a net energy importer, may feel the drop in supply more acutely.
Our positive view on the US economy relied on continued domestic consumption, which has remained strong thanks to real wage growth. However, if the worst outcome of a second wave of inflation is realised, a 2% increase in inflation is enough to wipe out real spending. The US jobs market remains muted, and the current war will do nothing to alleviate corporate uncertainty. Thankfully, some fiscal stimulus rom Trump’s One Big Beautiful Bill will come through in the first two quarters of 2026, providing some of an offset.
But the longer the war drags on, the higher oil prices rise and the longer supply of oil is restricted, the more of an economic crisis this could become. As a result, we have downgraded global equities to negative. We will naturally reassess if and when the situation resolves itself.
A continued war flips the broadening out theory on its head
Up until recently, we have supported the narrative of looking beyond US mega cap stocks to reduce concentration risk by accessing opportunities in the rest of the world, primarily in emerging markets, Japanese equities and the periphery in Europe. However, the war reverses this almost 180 degrees. The US is the least dirty shirt in this scenario, with EU, Japan and emerging markets most at risk from higher oil prices and supply constraints. The mega cap corporations still have excellent earnings and are high quality, despite higher energy prices impacting their AI costs. Therefore, we now prefer US mega cap on a relative basis, with the US remaining neutral, and have downgraded EU and Japan to negative. We have also downgraded EM from positive to neutral, as despite the higher oil sensitivities, regions like Latin America are perhaps set to gain in this scenario. Naturally, if the war ends tomorrow, we will go back to our original views, but for now we are erring on the side of caution.
USD upgraded as de-dollarisation pauses amid conflict
We have upgraded the US dollar (USD) to positive from neutral. We had been negative on the USD for a while, preferring other countries as we believed investors would shift away from US assets towards the rest of the world, given the relative improvement in global ex-US growth. The de-dollarisation story was alive and well, with the USD falling and currencies (along with gold) appreciated. We upgraded the USD to neutral recently on the view that too many rate cuts were priced and that the economy would be stronger than expected. With the outbreak of the conflict, investors flooded back to the USD. This is due to the relatively better energy situation the US enjoys, along with the return to assets considered quality like US equities.
Trump has also reminded investors what the USD is backed by – not gold but military power. We have upgraded the USD to positive as one of the few hedges in this environment. We do believe the de-dollarisation story will return, but not until the conflict is over.
Written by Sebastian Mullins, Head of Multi-Asset & Fixed Income, Australia