Capital in motion

Making sense of geopolitics

The first half of the year has reinforced a simple reality: markets are no longer driven by economics alone. Geopolitics, trade, strategic resources and autonomy in key sectors such as defence, energy and infrastructure are increasingly intertwined, and capital is moving accordingly.  

One consequence of this shift is how quickly market sentiment can change. For portfolios, this means periods of sharper market moves, in either direction, may happen, even if longer-term trends remain intact. Our focus is on ensuring portfolios can absorb these shifts, rather than trying to predict every short-term change in sentiment. 

Tensions in the Middle East and the recent rise in oil prices show how these forces play out. Markets initially reacted in a familiar way, with higher energy prices and increased volatility. However, the broader response has been more contained than in past episodes, suggesting that the global economy is starting from a more balanced position. 

This environment is shaping how we position portfolios today. We continue to hold a higher allocation to equities than bonds, supported by resilient earnings and a backdrop that doesn’t suggest aggressive rate increases from central banks. At the same time, we have actively taken profits on some of our tactical positions. 

These adjustments are intended to keep portfolios resilient. By reducing reliance on markets where performance has been most concentrated and increasing exposure to high-quality government bonds, we improve the portfolio’s ability to withstand periods of volatility linked to geopolitics, energy markets or shifts in market leadership. 

A different backdrop from 2022

The comparison with 2022 is understandable, but the context today is different. At that time, economies were reopening rapidly, interest rates were historically low, and inflationary pressures were already building before the energy shock intensified them.

Today, interest rates are already at restrictive or near-neutral levels in most developed economies. Inflation is still above target in several regions but cooling labour markets may help bring it down.

This gives central banks more flexibility, even if higher oil prices put upward pressure on inflation. A rise in oil prices does not automatically lead to a sharp tightening cycle. As long as higher inflation doesn’t become entrenched again, central bank policy responses could be more measured.

We do expect the US Federal Reserve, European Central Bank and Bank of England to raise interest rates modestly this year. But this appears to be largely reflected in market expectations. For portfolios, the likelihood of a sudden and aggressive shift in rate expectations, which was a key driver of volatility in 2022, seems relatively contained.

Rebalancing after a strong equity rally 

Emerging market equities have benefited from improving sentiment and optimism around global growth and technology supply chains. We increased our allocation to emerging markets around a year ago and built that exposure further as conviction strengthened over the course of the year. This positioning was followed by a strong rally across a number of markets, particularly in parts of Asia. 

After such a period of strong performance, with a rally of about 50% since we entered our overweight position, valuations in parts of the market have become less compelling and investor positioning more extended. We have actively reduced our emerging market equity overweight and taken profits. 

This locks in gains and helps mitigate the risk that strong equity price increases are given back if conditions reverse, particularly in some areas where performance has been most concentrated in just a few companies or sectors. 

This is not a change in our longer-term view on emerging markets, which remains positive, but a disciplined step to rebalance risk after a period where gains have been significant, to realise gains rather than leaving portfolios exposed if conditions reverse. 

Diversification matters 

If there is a single theme we hear when we speak with investors, it is that outcomes are becoming more varied and less predictable. Inflation shocks, political developments and technological shifts can all influence markets, sometimes simultaneously. 

In this context, diversification is not simply a defensive concept. It is a way of exposing portfolios to a range of potential drivers of return, while also including assets that may behave differently when conditions change. Within equities, this is reflected in how we position across regions and sectors. 

In the US, we continue to hold our equal-weighted index to diversify from the concentrated AI trade. European equities have lagged a bit this year, given their higher sensitivity to energy prices. However, we don’t want to reduce our current neutral allocation yet, as a potential end to the conflict might trigger a tactical rebound. 

Alongside equities and government bonds, commodities, gold and selected alternative investments (where permitted by regulations and investment guidelines) plays a complementary role in diversifying portfolios. This broad mix helps limit the impact of any single shock, whether driven by oil, geopolitics or shifts in market leadership.