Market Update - Uncertainty remains after US bombing of Iranian nuclear sites

Highlights: The US struck three Iranian nuclear sites this weekend, with planes dropping bombs on Fordow, Natanz and Isfahan. The US President urged Iran to now “make peace” while the EU urged “all sides” to begin negotiations. Markets have been most worried about a potential interruption to oil supplies, and that uncertainty remains. Much depends on Iran’s reaction, which we do not want to take a view on. In this publication, we have analysed the market reaction to date, which in a scenario of escalation would extend further, but could reverse if a path to peace is found. In any case, the elevated uncertainty supports our strategy to focus on portfolio resilience, with multi-asset diversification, quality assets, active management and long-term themes.

• The bombing will have come as a surprise to many investors, as the US President seemed to have given a 2-week window for a diplomatic solution on Thursday, and the Maga base is divided on whether the US should get involved in foreign conflicts. As a result, we expect an initial risk-off reaction when markets open on Monday. But what happens next will depend largely on Iran’s reaction, which is hard to predict
• We have analysed how markets have been reacting after 11 June and believe that in a scenario where there is further escalation, these moves could extend further. That would include a flight into safe havens including developed market government bonds, gold and CHF, while equity markets would see a further increase in volatility (VIX) and stock market weakness. From a relative perspective, energy is the only sector where we would expect upside but IT has been quite resilient too. US and UK stocks should outperform Eurozone and EM Asia stocks in this scenario. In credit, there should be a preference for IG bonds over EM bonds, but we note that HY has been relatively resilient thanks to its large energy exposure
• However, in a scenario where Iran’s retaliation is limited and negotiations point to a path to peace, we could see the moves since 11 June gradually reverse
• In any case, we think a focus on building resilient portfolios remains key, as the uncertainty remains elevated. We favour a multi-asset and active approach, including gold, quality bonds and alternative assets. Themes such as energy security remain very relevant