Fidelity Answers: How should I react to turmoil in the Middle East?

[MUSIC] We're only in March and already this year, due to political events with far from certain conclusions are again taking center stage. Second to the grave, human tragedy that's playing out in the Middle East. Investors are facing volatility, energy shocks and shifting macro outlooks. So for today's podcast, we wanted to share with our listeners views from no less than five of Fidelity's most senior experts, all of whom have been overseeing all themselves making the allocation decisions demanded of this challenging market backdrop. How should you react to the current turmoil in the Middle East? This is Fidelity Answers. [MUSIC] Hello, I'm Seb Morton Clark, and for this special episode, I'm very pleased to be joined by Capital Market Strategist, Castan Roomheld, who is on a fleeting visit to London from his usual base in Frankfurt. And he's going to be helping us work through some of these big issues that are facing markets at the moment. Castan, welcome. Hello Seb, it's great to be here. Very, very glad to have you here. Now our plan is to cover quite a bit of ground today. We're going to talk oil, equity markets, how it's handling everything that's happening, the change in direction on inflation, and how fixed income markets are digesting that, and what it means for growth, plus also the view on emerging markets, including China. Now we're able to hear from our investment team today because actually you are hosting them all on a webinar this morning here in the London office. What was the general mood there? I think the general mood was quite constructive, although risk factors have been increasing, obviously. But for some of these instances, historically, these were passed over in six or 12 months time. So I think it is necessary to look through what's happening right now. And maybe zoom out and have a longer-term outlook that's not so much impacted by near-term volatility. Okay, so the longer view is what's being adopted. Right, let's kick off with a clip that was recorded this morning. We're going to hear from Fidelity's head of global macro and strategic allocation, Salmon Ahmed. Here he is discussing the current risks facing energy markets. The straight-off and mood traffic has almost collapsed, although these are official numbers. Actually, numbers may be a bit higher because we do know that Iranian oil supply is passing through the straight-off or moods in countries like Russia, China and Pakistan are getting their tankers through that straight. But one, a surprise to say that the traffic collapse is quite a significant one. So crude oil, and it is not just a crude oil story. It also affects fertilizer and other supply chains as the shock accumulates. In this kind of an environment, our view has been that oil trades around $9,210 prices in around 10% of disruption to global oil supply, given that you have a east-west supply pipeline whereby Saudi and to a certain extent, you can offset some of that traffic from the straight-off or moods. And then you have some tankers which are as I highlighted still moving out of the straight. At this moment, with 100 dollar oil prices, I think the macro inflation shock is manageable for these central banks. They can afford to wait and be cautious, of course. But the more this sustains, if it escalates, then they become into a tricky situation because then the inflation shock becomes more immediate. And then you will also start to see the growth shock because of the mondestruction, given that 10% of oil supply is not available anymore. And oil is very inelastic in the short term. Our global head of macro, salmon, armoured there. Now, Castan, all of this remains very much in flux. And I'm conscious that whatever we say right now could very easily date quite quickly. But in general, could you just talk us through what the response from global markets has been to all of this? So global markets have been quite resilient, especially equity markets were only having corrections of 3, 4% altogether at the peak of the crisis right now. And if you look at the futures curve from the oil prices, they are coming down pretty rapidly. If you look out six months or so, we have an oil price of $80 or so priced in. So the market seemed to believe that the crisis is only transitory. And therefore, like Salmon said, it's not an issue where central banks have to immediately think about hiking or about a more hawkish course with interest rates. And as he said also, the duration of this crisis is relevant because we don't know what's happening. We don't know how the Iranians are going to block the straight and how long it's going to be. So the longer this goes, the more severe a shock could be. Fixed income markets have reacted a little bit differently. I think they have anticipated some more inflation in the inflation expectations. We've seen the longer end of the curve move up. So therefore a little bit more risk anticipation. The dollar has moved up, which was quite opposite to the movement that we've seen right before the crisis. But I think that is also due to the energy markets being priced in US dollars and the US dollar being a safe haven currency. So those aspects have played into the short term movements. And gold has also moved quite constructively altogether. And commodities are the one beneficiary of the overall complex. So some aspects have changed completely in markets recently. But as I said before, I think it's important for the mid to longer term strategy to look through the immediate volatility that we've seen creep up quite dramatically and try to assess what the longer term strategy and asset allocation might be. Obviously on many people's minds is how these rising oil prices are going to affect the consumer in particular. Most personally the US consumer. We heard Salmon this morning talking that the expectation at the moment is that price will hover around 110. At what price does it really become of particular pressure do we think from a macroeconomic perspective on the consumer? For the consumer the gasoline price is more relevant, especially in the US. And so you have to derive this from the oil price. But I would say that $100 oil price prolonged for like a 12 month period or so is already pretty painful. And it means that there are elevated gasoline prices which is much more important for the US consumers because they don't have any taxes on them. And of course the car and the usage of gasoline is much more demanded by them. And they react much more sensitive to a rising gasoline prices. So I would say a prolonged period of those levels would be really harming the US consumer. But let's not forget it's not only oil. There are also other aspects that are impacted. We heard from Salmon that also fertilizers are quite relevant. The market share from fertilizers coming out of the Middle East is not as high as from oil but still that means that food prices could go up. And so there is some more aspects being impacted. And therefore inflation rates could come up from many different sources if this lasts long enough. OK. More concern about inflation as you say. More concern about risk assets. And while we don't make bets around here, it would seem that there's a lot of hedging on everyone's bets at the moment. I'm going to avoid talking about central banks too much to say because we're recording this just hours before the Fed announces the results of its March meeting. Let's listen next to Fidelity's chief investment officer for fixed income, Marion Lemoydeck. Talking about the very practical steps she and her team of portfolio managers have been taking to deal with the change in the prevailing wind in inflation. We were of the view at the beginning of the year that inflation expectations in the market were actually priced too low. So we already had some long positions in the short dated inflation-breakup and space in the US and Europe, which obviously have worked really well. So we were already thinking that inflation expectations were very low. Now obviously, this is a shock at the moment. If you look at the future oil curve, what it tells you is that the market so far believes that in six months time, oil prices will kind of have a relief, however, at higher level as Salman did mention. So now the question is really how long this, as you said, this inflation situation, inflation uncertainty will remain. And what we know for sure is that volatility around inflation prints is something that the market has difficulties to digest. So what we've seen as a result of those tension on oil prices, we've seen very quickly a move up of interest rates on the short dated, it's two year or five years, ten years, we're in a very different situation compared to 2022 when it gets to inflation. At the time, well, first we started with very, very low levels of interest rates with central banks. We had zero point five percent rate in the US. And we also had expansion of the balance sheets of central banks at the time in 2022, which is definitely not what we are having now. The employment situation in the US 2022, we were creating 250,000 jobs, you know, amongst definitely not what we're seeing at the moment. we don't have that kind of. self-fulfining inflation dynamics that we are handed up happening in 2022. So I think fixed income markets really want to see how long that inflation shock is going to last on all prices, not only all prices, and then we will revisit our assessment on longer term inflation pressures. Chief Investment Officer for fixed income, Marion Lehmoyhadek there. Kostin, she was referring in her clip around the last time we had a big energy shock, 2022, wasn't handled particularly well by the central banks at that point. It's an interesting comparison, isn't it, to where we find ourselves now? There are some quite significant differences. Yeah, and the differences are mostly in the base where we came from. We had zero to almost negative interest rates before that shock in 2022 or 2021, even. It was before that. And central banks were pretty late in reacting to that because they thought the effects of COVID and then a little bit later on the Ukrainian crisis to be more transitory, although let's start with COVID. I think for COVID to be more transitory, and therefore they reacted pretty late in rising interest rates, but then in 21 the whole adjustment happened. And therefore risk assets reacted very negatively in 2021 to that. It's a different situation right now. Obviously we've got a much higher level of interest rates right now. We had I've gotten gotten a little bit more used to inflation because the COVID shock is still in the system and the base of inflation is still a little bit higher. But I think what central banks have also got in their minds is the situation back in the 70s and 80s where there was a similar development where we had one oil price shock, which was then moving over in central banks. Let's go of interest rates and then a second shock came on top of that and made it even worse. So central banks had to react in a much harder way and at the time it was 20% interest rates. There was some interesting comments in the in the discussion earlier around the different approaches of different central banks and actually there's sort of some of the flexibility that some banks might have compared to others. Tell us about that. First of all, if you compare for example the Fed and the ECB, the Fed has a dual mandate of course, which they have to watch the job markets and therefore it's a bit more difficult to adjust interest rates and the ECB has only the price mandate and you could argue they're at neutral levels right now which makes it a bit easier to basically stand still and watch developments going forward. I think at the time two price hikes are even in bond markets. These days anticipated, we don't know if that's going to happen, but I think generally speaking they've made it a bit easier to be more flexible with the inflation rate expectations and they can afford to wait a little bit longer before they react altogether. And therefore I think they will think hard and long and hard about what they're going to do right now and try to assess exactly when to move interest rates going forward. Okay. And Marron was also speaking there about the positioning that the Fixed Incom team is taking. Can you just elaborate a little bit on what you heard from that? Yeah, I think first of all, inflation expectations were priced too low at the beginning of the year and I think that's a fair assessment. So inflation hedging might be one strategy that you want to use in this situation right now with regards to government bonds and duration positioning. I think it's probably a bit more difficult and if you look at the debt situation for certain the global governments and the increase in debt that we've seen, especially in the US, but also in Europe and other parts, it's tougher to see a long duration strategy for the asset allocation because there's a lot of supply coming on markets with regards to government paper and at the same time, especially in the case of the US, there's probably less demand going forward because a lot of global central banks have tried to cut their US exposure, cut their US dollar exposure a little bit more. The trade policies also helping in that because less trade deficits from the states means less dollar moving into other countries. So I think there's not a great supply demand balance and therefore, you know, the longer the duration of this crisis goes, the shorter maybe the duration should be in the portfolio of government bonds. So I think that's with regards to government bonds and in the credit market, I think Marianne has been a little bit cautious. She said that credit spreads have moved quite low for the time being. They've moved a little bit wider in the crisis but there's not a lot of, you know, spread in, spread narrowing to be expected going forward. So I think the credit markets are reflecting a risk reward which is okay but not overly bullish altogether. So I think there's certain parts of the markets like high yield, for example, high yield bonds which have a good a good yield altogether which you can still, you know, take up but with regards to risk, as it's overall, we will come to equities in a moment. I think equities are still the better risk reward trade for the risk papers than credit is right now. And private markets, obviously also there is some growing concern around pockets there to what do Marianne have to say on that front? Yeah, the private markets. We've seen some cautious signs of private markets. Some signals coming out of big private market issues, private debt issues to restrict redemption, for example, and there's also been some defaults a while ago which Jamie Diamond, you know, titled is one cockroach is never alone, so to speak, there might be more coming out of the woods. So this private credit market which has expanded quite a lot in the last few years and investors have taken up a lot of this. Might show some signs of risks coming up and that could also impact fixed income markets overall. But I think you have to watch as always the private credit market exposure is pretty thoroughly because there might have been situations where, you know, due to nice and attractive yields, maybe the due diligence hasn't been done, you know, perfectly well. So there might be some things in the closet there. So as always, you have to really watch these things carefully, you have to do your research and then decide on which parts of this market you can expand on. But I think in general, private markets, the expansion of private markets is a good thing for diversification in the asset allocation overall. Okay, well, let's now turn our attention to equities. Our next clip is from Chief Investment Officer for Equities, Neve Brodie-Maturra talking here about the scenarios facing stock markets. Potential outcome one is that this is a short-lived, crisis, a short-lived conflict and Venezuela is seen as a playbook for that. That scenario, a scenario b is that this is actually an energy shock and a shock that could go beyond energy and something that could lead to stark flation. Now as I expect most of our listeners will know, the market has learned to incorporate short-term volatility, short-term conflicts within their expectations and they've learned not to sell in a panic to accept the volatility and look longer term and that's certainly something that we advise with our clients. But the second is much more profound. Stagflation is a really bad outcome for equity markets. When you have growth stalling, when you have inflation rising, it's not a good backdrop. As I said, the base case is still that this is a relatively short-lived effect that the front end of the energy market will come down. But how we are thinking about this, yes, our base case on equities is still positive. We think valuations are entirely manageable given the expectations of strong earnings growth. That momentum is really coming through. But we do advise being mindful of this watching, being careful of the data if it changes, you do need to change your perspective and right now we think resilience is really valuable. Kneef Brady, Matura speaking earlier, Kastin taking that into account, what worries you about the outlook for equity markets? As Kneeve mentioned, the stackflation aspect of things is the one that worries me most. When the current situation has an impact on inflation, on the one hand, increasing prices for oil, food and things like that for the consumer. At the other hand, suppresses growth and coming into a very difficult spot, especially for central banks, because that's the situation where they don't know and where they struggle most on what to do, because especially in the US, either you stimulate the job market by low rates or you fight price inflation with higher rates and that's a very difficult situation. And the stackflation scenarios, equity market performance was historically pretty bad over a certain amount of time. What in your mind has changed most materially for equity markets over the last few weeks? And what's the scenario here that you see where everything perhaps is okay? The one thing that has changed, and that's not only in the last few days, but over the last few months is that the earnings expectations, for example, for international markets versus the US, has been much more optimistic. So, especially for emerging markets, which is quite nice earnings growth expectations have been quite positive up to 20% earnings growth or so this year, before the crisis, obviously the crisis. prices is impacting emerging markets a bit more because oil prices and the dependency is higher for emerging markets there. But in general, that means it's a turn from the last 15 years or so after the financial crisis where the US has outperformed every single market every single year, almost. The dollar outlook has changed and that is also benefiting emerging markets in a way, strengthening their own currencies. The scenario is shifting a little bit and if this shock is not lasting too long, then I think the constructive outlook for equity markets is good, but the center of attention might be shifting from the United States to the emerging markets and to a certain extent to Europe. A perfect segue, thank you, Carlson, for our next clip. This is George Estartopoulos, who is a portfolio manager and co-head of multi-asset research. Here he is talking about his views on emerging markets starting with China. The media headlines where China gets more than 90% of Iran's oil, that was the headline. But context really matters because while that might be factually true, it's important to also put this in perspective because China relies about 20% of China's energy consumption is oil. Whole plays a big important role, but more importantly China over the past decade or so has managed to really diversify its energy consumption inputs and now it has that big shift towards green energy. That is very, very important because if we also think about China's power generation, actually oil plays a very, very small part of that. As a result, China has actually been quite resilient and also going to be on that. If we look at some of the data in China coming through for the first two months of this year, exports, very, very strong, exports have been strong because global growth has been very strong. Maybe that might, we might see sort of that growing over somewhere, but China has also been very, very competitive and I don't see that changing as an argument. And increasingly we see some better data coming from the domestic consumption story. Retail sales were actually a lot stronger than markets were expecting and they have been this strong since about a year ago, may have last year. But it's not just a China story. We look at other places like Korean equities. Yes, they've had a big correction, 20% down at the trough. Most of that now has come back, 70%, 70% of that, if we include today, big rally today in Korean equities. And the important thing is that Korea is at the heart of the AI Capix cycle. It used to be sort of from the free cash flow in US corporates, about 50% of that was going into buybacks. As of the end of last year, that was 15%. All of that free cash flow is being spent on Capix and all that Capix is going to places like Korea and like Taiwan. So very strong fundamentals, a bit of a position shakeout right now, but very strong fundamentals which justifies the better performance we've seen in the past few days. Portfolio manager George Eftopoulos talking their cost and quite a bullish outlook from George there. I would say so absolutely and I would say that China is at the center of attention in emerging markets. Obviously, but it's not the only one. I think emerging markets in general have the benefit of being able to compensate for these trade changes that the US has caused and they are able to shift their flows into other parts of emerging markets, into Europe, into the south part of the world and therefore being a bit more resilient. Also, I think their balance sheets are much more resilient. We remember in earlier times when there was a crisis in Asia, it was even elevated. So Asia was even mostly going even worse in crises. So I think China, the risk sentiment is pretty low. Capital flows have been moving away from China. People are much more cautious these days, but actually the economy is slowly recovering in China. We have heard from George, even the consumers recovering, exports are doing well. So China is pretty resilient and they've also they've also shortened their dependency on oil by other fuels. They're leader in alternative fuels and the solar market, wind market, which you might not believe, but it's the case. So I think China has become much more resilient and of course it's the source of all these rare earths of a lot of important materials going forward and they've in parts of the market have got between 70 and even 100% market shares of those important materials. So I think they're pretty important and they increase, I think, a positive outlook for the overall emerging markets. Of course, emerging markets was the story at the beginning of the year. In part because of what was happening with the dollar, that has changed a little bit of late. What's your expectation there and what impact do you think that will have on emerging markets? It's important to zoom out a little bit and of course short term volatility is maybe impacting the story slightly but the longer term effects I think in terms of growth in emerging markets, in terms of their resilience, in terms of their access to commodities, in terms of their growth of the middle class, all these aspects are still in play when you look at asset allocation for the next 10 to 20 years rather than the last 10 to 20 years where the US was the most important part of equity markets. The part of Asian markets in the MSCI world for example, also are pretty small. They're around 10% or so allocation. And if you look at future growth aspects and all these things that I've talked about, then you could certainly see those allocations being increased quite dramatically over time. Okay, well let's switch back to the US now and the AI story. We're going to hear one final clip from Neve Brody-Motura, Chief Investment Officer for Equities. I think geopolitical headlines matter being an energy importer matters, but you do need to think about what is actually driving the earnings. And when we look at emerging markets, you've seen 20% positive earnings revisions in recent months. Now earnings are expected to double between 2025 and 2027. That type of momentum is really strong and it is a large part of it is more immune to the energy effect. The US market has been driven by this for a number of years now. Expectations are for 15% EPS growth. It looks like the AI trade will be supportive of that 2026 is the year of the agent. This is a really, really important moment when we have tools that can go end to end in terms of work processes that can take feedback that can learn and that can improve every technologist that our team talks to, the corporate management. It is really happening. So as we looked at this in 2025, we thought, okay, the capex is happening. The spend is happening. The monetization remains an extremely big question mark. That question mark is starting to be answered with more and more use cases and more and more confidence in the ability to actually fundamentally change how people work. Now, this means our demand steam roller is there and our technology analysts are saying the whole way through the supply, hardware, the energy grid, the all of the infrastructure needed to make this happen. That demand is there. But it reintroduces the two paradoxes that we've spoken about. The first is can every corporate be a winner, can every business model be a winner and the second is economically is everybody a winner from this. The market has honed in really sharply on that first question and it has differentiated between AI winners and losers. On the economic question, here we need to rely on Salman, on the expertise and on the data that will come through to understand will we walk that tight rope where there will be productivity gains without a very serious impact on labor markets and consumers and for us that's still an open question. Chief Investment Officer for Equities, Neve, Brodie, Mature, Speaking there. Now, Karsten, we've just run our annual analyst survey. That's a responding respondents from over 120 analysts across the globe at Fidelity. The story that comes through there, as Neve was saying, is very much that we are still in this industrial investment boom phase of the AI revolution. So that's the energy, that's the power, that's the installation of the infrastructure that's being built out. But the rest is still to come, as Neve was alluding to there. This year of the agent as she refers to, you agree with that? Yes, I fully agree with that. And I think the topic of AI was prevalent before the crisis and it will come back after the crisis, of course. And the market has tried to differentiate a lot more between winners and losers in the AI market because before, as Neve also said, the market was lifting all boats, especially the infrastructure, people that were offering chips and servers and all this infrastructure. But we've also seen the enablers, like the software companies and consultancies being sold down because they, you know, people thought maybe they wouldn't be necessary because companies could, you know, introduce AI by themselves and go from step one to step three, so to speak, and get go to the profitability curve once again. I don't think that's the case, but that means this differentiation, it is taking out a little bit of the dynamic for this AI boom, especially for the US, because the beneficiaries of the first wave are mainly in the US, but the beneficiary of the second and third waves are outside the US. So it also means that the dynamic from this push to growth will shift through the world and will make it much more possible for other countries under other companies to benefit from that. It's really interesting what you have to say there about the paradox there. So you mentioned yes the winners, the losers of the AI build out, but that economic question where she says the jury is still out in terms of the shape of growth and the beneficiaries within society. Where do you see that playing out? It's very tough to say right now. There's certain extreme opinions on both ends of the curve. The one extreme opinion that I will quote now is the one where people have argued that this profitability increase is only benefiting the hyperscale as the billionaires that provide these business models that hold that own these companies and all the yields will revert to them. So to speak it will not have a consumer effect. And if the consumer effect is missing then the consumer cannot participate in that boom. It cannot benefit by higher wages, by whatever more money to spend. And if that's missing then it means it will be sort of speak ghost economy in some ways that was quoted once again. If that's the case it would be very bad for society. It would be increasing the split between rich and poor even more. And I think it wouldn't participate or have participate the consumer in that expansion. I hope and I don't think that's going to be how it's going to be working because I think the job market will shift. But it will not be that people will lose its job and will generally be replaced by AI. But job profiles will shift around. And we don't know yet how it's going to be. We can only hope that the profitability increases will also fall on the consumer and therefore increase the consumer power for economies going forward. Because that is the big question that we can't answer right now. Any predictions or thoughts on how the current situation in the Middle East and potential bottleneck on energy, how that might affect the build out of AI, the AI wave that we have been witnessing? I think the most important aspect of that is energy. And because the whole AI infrastructure has seen so many investments right now and so much money and capital flowing into it, and it's dependent on a lot of energy input. And we haven't fixed that kind of bottleneck yet. Because I believe that not every project that is planned right now can be built in the same manner as it's planned because it requires a lot of energy input. And as energy is limited on which side ever be it that we have less oil flowing, be it that maybe some countries are restricting the nuclear access to energy and speaking of my own country at that particular point. But that means that for the AI boom to expand completely and the whole infrastructure to be built out, we need all the energy that we have. And I think that might be one of the bottlenecks going forward. And it might maybe destroy some of the business models that have been planned right now. So you have to watch the amount and the price of energy going forward for that expenditure to happen. Okay, it's going to be going to be critical as you say. Right, well before we bring things to a close cast in, we're going to play our traditional game hotcakes and hot potatoes. And I'm not sure actually we've even warned you about this. So I'm really putting you on the spot. So what assets are looking tasty to you? What would you be buying up at the moment? And what might you treat with a bit of caution? So taking into account everything you've heard today, it's been a busy day for you. What would be your hotcakes? The hotcake would be the whole commodity aspect. Because I think that the access to commodities and the amount and the supply of commodity is limited going forward, I think we haven't spent too much capex on this particular sector in the last 10, 15 years. And that might cause problems going forward either with the supply or the price, whatever it may be. So I think commodities are a good hedge against those possible price increases and supply or short supplies that we see for the future. Because even for the energy infrastructure to be built out the electric infrastructure, for example, we need a lot of copper, a lot of infrastructure where I cannot see the supply being enough for that to happen going forward. I think that's a good hedge for inflation and a good asset education position in general. And a hot potato for me would be government bonds. I have to admit because they might be a safe haven for certain amounts of short time. But I think the way the government debt is increasing these days and the way the government is interfering with a lot of things in markets, throwing money at all the problems that they have is not giving a great outlook, I think, for the government bond. Area. So that would be my hot potato, I think. Okay, very good, even though you were on the spot. Right, well, we are going to release you now. You have a plane to catch. Thank you very much, Carson, for your time and your thoughts today. That's all we have time for. So I'm going to say thank you to our chief investment officers, Neve Brodie-Muchura and Marion Lemoydeck, to our head of global macro and strategic asset allocation, Salman Ahmed, and to multi-asset portfolio manager George Eftethopolis for all of their contributions today. You can find out more on the topics that we have discussed today on your local fidelity website or at fidelityinternational.com. You can read our latest analyst survey that I mentioned earlier that will be live on websites and of course a replay of the webinar that Carson hosted this morning with all of our CIOs. The producers today were Patrick Graham and Rachel Reed with production support from Connor Bailey, Peter Reese and Alex Wilcox for now from all of us at fidelity. Goodbye. This podcast is for investment professionals only and should not be relied upon by private investors. This podcast is provided for informational purposes only and is intended only for the person or entities to which it is sent. It must not be reproduced or circulated to any other party without the prior permission of fidelity. The value of investments can go down as well as up so you may get back less than you invest. For other important legal notices, please visit your local fidelity website.