A geopolitical shock sends inflation and rate expectations sharply higher
Markets retreated sharply from recent highs as the start of the conflict in the Middle East forced a rapid re-appraisal of the outlook for inflation and interest rates, following a spike in oil and gas prices. Trading was volatile, with sentiment vacillating between hopes for de-escalation and fears of a prolonged conflict.
A broad-based sell-off, with few places to hide
On February 28, the US and Israel launched coordinated airstrikes on Iran, killing the Supreme Leader Ali Khamenei and targeting leadership, military and nuclear infrastructure. Iran retaliated with missile and drone strikes across Israel, the Gulf States and US regional assets. The Strait of Hormuz, the 3.2-kilometre-wide shipping channel through which around 20% of global oil and gas supplies transit, was effectively closed.
The consequences reverberated through energy markets, heightening concerns about supply disruptions. The price of Brent crude oil surged from $72 per barrel on the eve of the conflict to $118, a spike of 64%. The move marked oil's largest one-month gain on record, triggering a decline across financial markets as investors worried it would lead to a re-acceleration of inflation, with negative consequences for both interest rates and growth. Gold, typically a safe-haven asset, fell by 11%; after the best year for gold prices since 1979 in 2025, it was not immune to the general trend of profit-taking among assets that had performed well.
The sell-off was broad-based, by both country and sector, with few places to hide outside energy and defence-related stocks. Previous high-flying markets experienced the sharpest falls: Asia, Japan and Europe declined by 11.6%, 10.7% and 8.2% respectively, while UK equities closed 5.9% lower. The US, which had not performed well in recent months, held up best in relative terms with a fall of 3.2%. This relative resilience also reflected its status as a net exporter of oil and gas. The tech-heavy NASDAQ index, however, fell by 11% over the month.
Energy stands alone as bonds reprice for inflation
At a sector level, energy stocks were the standout performers, as producers, refiners, shipping and infrastructure companies all stand to benefit from materially higher oil prices. Basic-material companies such as miners, chemical and fertiliser producers were also seen as beneficiaries of supply disruptions. In contrast, airlines, travel, consumer discretionary and financial stocks were the most negatively impacted, along with premium-valuation stocks within technology and AI.
Government bonds declined as yields moved higher amid renewed fears of a reacceleration of inflation around the world. UK gilts faced further pressure from political uncertainty, with unease that the outcome of the May local elections could shift the power balance within the Labour Party further to the left. Investors bought near-term inflation protection, to the benefit of short-duration index-linked bonds.
Inflation re-accelerates, and central banks change course
UK GDP surprised to the upside in the three months to February, with growth of 0.5%, suggesting the economy was starting to recover before recent events. March data, however, saw the first visible pass-through from events in the Middle East, as the inflationary picture worsened. CPI rose to 3.3%, driven by higher fuel costs. Previous consensus had been for inflation to fall to 2% in the second quarter; the spike in energy costs now means it is forecast to rise to 4% in coming months. As a result, the Bank of England held interest rates at 3.75%, having been widely expected to cut before the conflict broke out. Market expectations of at least two further cuts this year have morphed into the possibility of a hike, given the rise of almost 1% in the 2-year gilt yield.
In the US, the March CPI print at 3.3% also confirmed that short-term inflation is re-accelerating, undercutting the case for the Federal Reserve to lower rates anytime soon. Other macro data for March was mixed. Consumer-sentiment indicators reflected the pain being felt at the pump, with the University of Michigan's reading falling to a record low; the ISM manufacturing index, however, continued to tick higher.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
A ceasefire rally, but the inflation question hardens
At the time of writing, markets have rallied on news of a ceasefire between the US and Iran. While a peace deal has yet to be agreed, confidence is growing that both sides appear keen to find an off-ramp; the next stage of escalation would be damaging for everyone.
In economic terms, while a short-lived spike in the price of oil is unlikely to have a lasting impact, a sustained increase in energy costs would lead to higher inflation and weaker growth, delaying expected interest rate cuts. These events are unlikely to impact global corporate profits over the long term, however, and the possibility of rate cuts could quickly re-emerge on any resolution and drive a recovery across markets.
As inflation risks have increased, the case for owning real assets has strengthened. We entered the year with a positive view on commodities. Going into the crisis, energy was arguably the cheapest major asset class in the world, with both oil and natural gas trading near extreme undervaluation relative to equities, at levels historically associated with major bull markets.
The supply of oil and gas is likely to remain constrained, and prices elevated, for some time, even with a peace deal, because so much infrastructure has been damaged. But the energy constraint is only the first layer. The global economy is simultaneously experiencing an unprecedented demand cycle for commodities and critical metals, driven by the buildout of AI-related data centres, the modernisation of electrical grids, investment in renewable energy, military expansion and the reconstruction mandates in Ukraine and the Middle East. Higher prices will likely be required to encourage the new investment needed to fund these sources of demand.
Investing in markets is not the same as investing in the underlying economies.
On an economic basis the US remains in good health, while developed economies outside the US look less robust. Regional market composition and valuations, however, paint a different picture. On a sectoral basis, the US, with its heavy technology bias and premium valuation, is likely to fare worst in a more inflationary environment, as we saw in 2022 coming out of the pandemic. The UK presents a more interesting case: the market is significantly overweight energy and commodity stocks, which have performed well during past oil spikes. Its 16% weighting in consumer staples and 10% in energy are more than double any other major market's allocation to either, while its exposure to technology is minimal. It also remains one of the cheapest markets globally. Although also relatively cheap, the composition of Japanese and European markets is more challenging, as their large industrial and consumer-discretionary sectors are likely to present a headwind.
Periods of volatility such as those seen in March are a reminder that sentiment can shift quickly when positioning is concentrated. Our response is not to react to price but to hold well-diversified portfolios, anchored to long-term fundamentals and explicitly constructed for a range of possible outcomes, including a more inflationary environment.
Discipline through volatility
A common pattern is that investors become more cautious after markets fall, reducing risk at precisely the point where valuations become more attractive. Over time, this tendency to react to price rather than fundamentals can lead to weaker outcomes, and helps explain why the average investor earns lower returns than the market. We focus instead on creating resilient strategies designed to navigate a wide range of conditions.
Diversification beyond bonds
Broader diversification incorporating additional asset classes such as precious metals and commodities remains essential. While bonds offer attractive yields and can help insulate portfolios in the case of slower growth, they will not protect portfolios if inflation remains higher for longer. We have explicitly considered the potential impact of a more inflationary environment in our current portfolio construction.
An increased weighting in energy
Exposure to the energy sector has been increased in recent months. Prior to recent geopolitical developments, oil was arguably the cheapest and most disfavoured major asset class in global markets. Energy equities account for a mere 3% of total US market capitalisation, barely above the pandemic-era lows. The prevailing view has been that the oil industry belongs to a bygone era; the same sentiment was evident toward gold in the late 1990s, shortly before it embarked on one of the strongest bull markets in modern history.
Conviction in gold and silver
Our constructive view on gold and silver remains unchanged. Gold continues to play a critical role as a portfolio diversifier amid geopolitical uncertainty and concerns around government debt and currency stability. At the same time, precious-metal mining equities are benefiting from strong pricing dynamics, supporting robust profitability and sector-leading growth.
Underweight the United States
Within equities, our allocation to US equities is significantly lower than a passive market-capitalisation-weighted approach. This leaves portfolios underweight the mega-cap technology stocks, whose rate of return is likely to lag other parts of the market following a 15-year period of extraordinary returns. We believe other markets offer a better long-term return and risk profile.
The United Kingdom comes back into vogue
The good news for the UK is that the market has many of the "old economy" companies that are suddenly coming back into vogue. Our UK exposure is biased towards cyclical, domestic and value-orientated sectors, along with small and mid-cap companies.
Emerging markets and Japan
Emerging markets continue to trade at a significant discount to developed-market peers despite a superior outlook for growth; we expect this valuation gap to narrow as supportive structural trends feed through to corporate performance, with foreign investors still structurally under-allocated even after strong performance in 2025. Japanese equities, meanwhile, remain underpinned by attractive valuations, a pro-growth policy agenda and robust earnings, with ongoing corporate-governance reform returning more capital to shareholders through buybacks and dividends.
Capturing the upside, controlling the risk
We continue to manage investments in a manner that allows us to capture the upside in financial markets while also effectively controlling risk, to dampen volatility and smooth the path of returns. This is the discipline our clients have come to expect, and the one we believe best serves the long-term stewardship of capital.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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