How the Iran War Is Impacting Investment Portfolios
Outside of commodities the biggest moves have been in bonds, where short-term yields have spiked. But the upward pressure on longer-dated bonds has been less extreme compared with previous market shocks like the 2022 inflation surge caused by the Covid pandemic and stagflation in the 1970s. At the same time, expectations for economic growth have not been heavily impacted by the war, which has limited the pain for stocks.
We spoke to Mueller-Glissmann about how markets are responding to the war in Iran and his view on the optimal portfolio.
Why didn’t stock markets decline more due to the Iran war?
We’ve been surprised by how resilient equities have been in the face of both the energy and the rate shock. The big concern now is that the rate shock eventually weighs on growth expectations.
There is going to be some lasting damage, and our economists have downgraded their growth and upgraded their inflation forecasts pretty much around the world. But the growth pricing has been remarkably resilient across assets as well as within equities, and by extension, equities have also been resilient.
Why is that? I think there are two elements. First of all, there’s a certain concern about reversal risk. Around the Liberation Day shock when equities reacted very strongly, the market aggressively re-priced growth, and then you got a pivot on the policy side that prompted a major reversal in markets. Maybe investors have been reluctant to adjust portfolios too aggressively around the geopolitical shock this time.
But the other thing that’s important is that the macro conditions with which we entered the year were very strong. We had the Big Beautiful Bill, which supported an expectation for above-trend growth in the first half of the year. And tracking GDP growth estimates were above 3%. That means that you had a very good anchor in terms of growth. The same is true globally—we were right in the middle of a cyclical acceleration.
So the market went from being very optimistic overall to being less optimistic, but it has not turned bearish so far.
How are rising interest rates impacting investment portfolios?
Generally, when you get a rate shock, it weighs on 60/40 portfolios and means that bonds cannot help you in buffering growth shocks. The risk is always that the rate shock becomes a growth shock, because higher rates tighten financial conditions, tighten credit conditions, and can weigh on markets more broadly, which can in turn feed into growth.
This time, the rate shock is so far particularly large in short-term rates, not in longer-term rates. And I think there are a few reasons for that: First of all, inflation in 2022 (when Russia invaded Ukraine) was already at 5% with strong demand from the reopening after Covid shutdowns—and then you had an energy shock on top. This time, inflation was much lower, much closer to central bank targets.
And the other big difference is the starting point of bond yields. Compared with 2022, bond yields are much higher going into this inflationary period. In 2022, you had the Covid crisis leading to a sharp collapse in bond yields, and because inflation already picked up in 2021 going into 2022, real yields were very low. At the beginning of the year, the 10-year real yield for Treasuries was close to negative 100 basis points and increased to more than 150 basis points in a few months due to aggressive central bank tightening. Now, if you look at real yields for longer-term government bonds, they’re already quite high at around 2%.
What’s the outlook for 60/40 portfolios this year?
Our baseline expectation would be that markets eventually recover after a continued period of volatility. Our macroeconomic baseline for the rest of the year is that we won’t have a recession, we won’t have inflation unanchored in a significant way, and that means that over the medium term, growth expectations will stabilize and 60/40 portfolios will recover.
Our machine-learning based model that predicts the likelihood of a sustained decline for 60/40 portfolios for the next 12 months is still reasonably low because growth is still good, inflation is not accelerating as much, and policy is still easing.
