Escalate to de-escalate: Dramatic ceasefire between Israel and Iran. Just like that, the war in the Middle East may have ended with Trump announcing a ceasefire between Israel and Iran. While neither country has confirmed this, Iran did say that if Israel stops its attacks, it would follow suit. So far, Israel has yet to comment on the ceasefire and the ball is now firmly in its court.

If this ceasefire plan pulls through, it will amount to a dramatic de-escalation of the crisis that unfolded over the weekend after the US’ attacks on Iranian nuclear facilities. Above all, this will also amount to a massive “win” for President Trump who took a high-stake gamble by inserting US into a worsening conflict in the Middle East—a complete shift from his campaign promise of ending the US’ “forever wars”.

According to news sources, the strikes on Iranian nuclear facilities are meant to be one off and the US has no intention for a regime change in Iran. Indeed, to appease isolationist rightwing allies and the MAGA movement, the Trump administration has drawn a fine distinction by specifying that the US is not at war with Iran per se. Instead, it is at war with “Iran’s nuclear program”.

Iran: Limited options on the table. While the world waits for events and fresh developments to unfold, we believe that the options available for Iran is very limited, given the following:

• Military capabilities severely curtailed: Retaliatory attacks on US bases and energy infrastructures in the Middle East would have been an obvious option for Iran. However, the country’s military capabilities have been severely crippled by airstrikes. Given the combined military capabilities of US and Israel, Iran knows this is a war which it has no chance of winning.
• Limited involvement from external parties: We do not envisage Iran’s key allies—Russia and China—to come to the country’s rescue in this conflict. Apart from rhetoric and grand political statements, putting military resources on the ground in the Middle East will be out of question for these countries.
  Russia, for instance, is stuck in a war with Ukraine and has limited spare military capacity to be involved in Iran. More importantly, the strategic partnership which both countries signed this year is not a military alliance. Hence, Russia has no obligation to come to its rescue.
  In the case of China, the country is saddled by domestic economic issues and the ongoing tariff war with US. Its partnership with Iran is driven predominantly by economic interest (i.e. Iranian oil and access to the Strait of Hormuz) as opposed to strategic and ideological reasons.
  The lack of involvement from Russia and China will ensure that this crisis is contained within the region.
• Closing the Strait of Hormuz – A case of economic self-harm: Another option for Iranian retaliation will be the closure of the Strait of Hormuz, a trade route whereabouts one-fifth of the world’s oil supply pass through daily. The strait lies between Iran and Oman and is one of the most important chokepoints for oil in the world. Iran uses the strait for its oil exports (in particularly to China) and its closure will therefore amount to economic self-harm.

The lack of good options on the table perhaps explains Iran’s highly performative “retaliation” against the US by firing missiles at an empty airbase in Qatar that had been evacuated days earlier. The mild Iranian response is clearly designed to de-escalate the crisis and return to the negotiation table.

Past market selloffs on geopolitical shocks tend to be short-lived. Our analysis of past conflicts suggests that geopolitical shocks in the Middle East usually only result in short-term drawdowns with markets rebounding within weeks. On average, global equities fell c.0.8% in the first two weeks following major conflicts in the region, before rebounding c.4.1% on average after three months. In fact, global equities surged 11% three months after the Red Sea Crisis and Gaza war in 2023.

Using history as a guide, we believe that the current conflict will stay contained as long as Iran refrains from closing the Strait of Hormuz—a move which will inflict economic self-harm and therefore, highly unlikely. On balance, tactical pullbacks in such crises present buying opportunities in quality assets if one can withstand near-term volatility.

How to invest?

Equities:

• While Trump has proclaimed a ceasefire in the Israel-Iran war, actual enforcement by both countries is uncertain and the situation remains fluid. Expect oil price to stay volatile and the likelihood of potential spikes to remain.
• Based on conventional wisdom, higher oil price is negative for corporate earnings as it translates into higher cost of production, though our analysis of past trends suggests otherwise. Historically, global equities have only delivered negative y/y returns during periods where oil prices spike above USD115/bbl. Notable instances of this include the 2011-2012 Middle East political turmoil and 2022 Russia-Ukraine war.
• Given the low likelihood of Iran shutting down the Straits of Hormuz, we assign a low probability of oil prices that breach beyond this threshold and this translates to limited downside risk to equities at current levels. That said, divergence in performance could take hold if oil price stays elevated:
  • Shipping and Airlines: Fuel typically represents one of the largest variable costs for both industries and if not sufficiently hedged, may result in significant margins compression. Furthermore, airlines would need to reroute flights to avoid the conflict zone’s airspace, resulting in longer flight distances and the further increase of fuel consumption.
  • Consumer Discretionary: The higher oil prices will increase inflationary pressures, prompting consumers to tighten household budgets and reduce discretionary spending. The autos sector could also face additional downside risks as higher fuel costs further dampen demand.
• In a volatile geopolitical environment, we advocate a defensive tilt and maintain exposure to the following:
  • Consumer Staples and Healthcare: These sectors typically exhibit inelastic demand as consumers continue to spend on essential goods and services regardless of broader macroeconomic headwinds. Their earnings resilience and low economic sensitivity make them well-positioned for periods of uncertainty.
  • Defence: In the current VUCA environment, defence spending is seeing renewed focus. Notably, Europe has launched the ReArm Europe initiative, targeting up to EUR800bn in investment to strengthen the region’s defence capabilities across member states.

Bonds:

• Trump’s petulant “show of strength” in both his economic policymaking and geopolitical manoeuvres, followed by self-aggrandising reconciliatory gestures, is finally proving to be unconvincing to the markets. Crude oil volatility (proxied by the OVX Index) persists near a 3-year height even after the announcement of a ceasefire. Yet, even as volatility, inflationary pressures, and recessionary fears remain sticky, investors should not be detracted from the resilience quality bonds that have historically displayed during and after such volatility events.
• In our analyses, investment-grade (IG) credit has resisted drawdowns in 13 instances of oil and geopolitical volatility shocks over the last 14 years and has proven to be a strong tail-risk hedge in a portfolio. That said, there are important nuances to consider in adopting an IG credit strategy amid geopolitical uncertainty.
• Firstly, investors need to make selective picks in A/BBB credit—and only the 1-3Y duration segment in BB credit—for strong balance sheets to withstand default risks against the more volatile geopolitical backdrop. Investors will also do well to look at stagflation-resistant bonds, including TIPS and capital securities.
• Secondly, on duration, we continue to advocate a barbell duration strategy, overweighting 2-3Y (i.e. the Liquid+ strategy) for the certainty of returns and outperformance over cash and the 7-10Y segments to capture high yields. The 7-10Y segment, however, will require timing of entry, given elevated volatility.
• Finally, the prospect of an extended conflict could aggravate US fiscal trajectory and ultra-long duration bonds will likely be at risk.

Currencies:

• In a typical reaction to geopolitical conflicts, the USD’s safe haven characteristics have indeed been triggered. It is not surprising that investors should seek refuge in the world’s strongest military power. In a similar vein, the historically neutral Switzerland and CHF have also been seen as a safe harbour in this episode. The JPY is an outlier this time as the market has been more focused on the less hawkish-than-expected BOJ decision on 17 Jun.
• Based on historical precedents, the USD tends to appreciate around 3.0% on average at the start of major Middle East conflicts. A similar USD bounce was noted in this episode. Alongside the deterioration in cross-asset risk sentiment, the DXY Index bounced off its 12–13 Jun lows, although to much muted levels.
• The CHF has also largely kept pace with the USD’s bounce. However, given that the current base case does not expect a severe and protracted risk-off scenario, expect any risk-induced USD-positive dynamics to be temporary.
• The structural, more durable, drivers are US tariffs, fiscal concerns, and the weakening of US growth relative to the rest of the world. Expect the market to quickly revert to these USD-negative drivers in the upcoming days. Thus, any USD rallies in the interim could be an opportunity to sell at better levels.

Gold:

• We have been consistently advocating for gold as a hedge for geopolitical conflict and uncertainty and continue to do so despite the muted price response to the latest US strikes on Iran.
• Latest reports have confirmed a ceasefire between Iran and Israel, and markets are also signalling for a contained conflict, but given the volatile and deep-rooted nature of the disputes, we could very well see developments to the contrary in the coming days. Amid such uncertainty, there remains a strong investment case for gold as a portfolio risk diversifier.
• Should there be a failure to reach a ceasefire and/or re-escalation in tensions, gold prices could rally again; gold has shown itself to be sensitive to material developments in the region as evidenced by its stellar 9.5% rally during the inception of the Gaza war in Oct 2023.
• Even in a sustained de-escalation scenario, gold will retain its shine as it benefits from other structural tailwinds, including the growing US fiscal deficit and rising recession/stagflation risk from tariffs.

Oil:

• It would appear that the worst is over for oil, Trump has declared a total and complete ceasefire between Iran and Israel and that a peaceful resolution to the conflict is in the works. However, the situation continues to be volatile with details of the truce yet to be confirmed.
• A similar situation transpired in May this year with Trump announcing on social media that Russia and Ukraine had agreed to a ceasefire, though it subsequently failed to make any progress on peace negotiations after.
• Using recent history as a guide, investors should continue to view the Iran-Israel conflict from a probabilistic view until further information comes to light. For now, the best-case scenario of sustained de-escalation applies, but potential re-escalations and oil price spikes are still on the cards.