Geopolitical risks return, growth remains supported

At first sight, the renewed attacks between Iran and the US may appear to bring the conflict back to square one. However, we do not believe that is the case, although downside risks have of course increased. The period where energy could flow out of the Gulf has created a small buffer for the world economy. Additionally, there is still a framework agreement in place. We continue to believe that it is more likely than not that we see a new agreement as both sides retain strong incentives to negotiate. Iran wants oil revenues while the US is focused on limiting the impact of higher energy prices on the cost of living. Overall, we are sticking to our base case as oil prices remain in line with our expectations. That is, we remain constructive on the global economy due to a trifecta of capex booms and expect economic growth in all major regions. Specifically, the investments in AI, the energy transition and of course defence spending provide welcome support for the world economy.

Equities have performed solidly this year despite a volatile geopolitical backdrop. Specifically, the information technology (IT) sector and its semiconductor subsegment have profited from the high capex spending. However, as equities rose, IT valuations became stretched, and volatility is rising as investors are questioning the longevity of the AI capex boom. The earnings season for the second quarter has officially started and although the first quarterly earnings reports are encouraging, there are signs that some equities are priced for perfection. Companies that fall short of high expectations are punished by the markets. Therefore, we expect that this summer can bring volatility in financial markets which is why we recently reduced both our equity position and our position in information technology to neutral.

Earlier this year, we decided to increase our position in investment-grade (IG) corporate bonds at the expense of sovereign bonds. Now we increase this position further as we deem IG corporate bonds the most attractive investment within the high-quality (HQ) bonds segment. Several factors support this view. We fund this investment by selling HQ sovereign bonds. First, a solid macro backdrop provides a good environment for corporates. Second, corporate balance sheets are generally strong, while sovereign debt loads are elevated, which we expect to remain a struggle as countries need to increase their defence spending. Additionally, IG corporate bonds provide higher yields than sovereign bonds while providing a comparable risk profile. And although IG corporate bonds are expensive from a historical perspective, country spreads for sovereign bonds have also tightened significantly in recent years. This makes IG corporate bonds more attractive compared with sovereign bonds.

The re-escalation of the Iran war has increased downside risks, but it has not changed our broader economic outlook. We still expect an agreement between the US and Iran and strong investment trends in AI, the energy transition and defence spending continue to support global growth. Although equities also benefit from these investments, they have already had a strong run which can cause some volatility over the summer. Therefore, we have recently reduced our position in equities and the information technology sector to neutral. Within the HQ bond portfolio, we increase our position in IG corporate bonds and reduce our position in sovereign bonds as IG corporate bonds provide a more attractive risk-return profile in the current environment. Finally, we hold a position in gold which provides portfolio diversification and should benefit from long-term structural tailwinds.

Richard de Groot
Chair Global Investment Committee