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Up2Date - Markets are trying to assess the risk of stagflation
As the war in Iran drags on, volatility tends to increase in financial markets, which nevertheless continue to price in a short-lived conflict. Futures market indeed expects Brent crude falling from close to USD 100 per barrel currently to around USD 80 by year end. This outlook, together with the earnings growth expected to rise by 18% in 2026, explains why equities have given up only around 5% from their recent highs. Beneath this apparent calm, however, sharp moves are taking place, particularly across sectors and regions most sensitive to energy costs and to stagflation risks (weak growth and inflationary pressures). The near closure of the Strait of Hormuz and the destruction of oil and gas infrastructures are logically more detrimental to Europe, emerging markets, and to sectors such as industry, materials and transportation than to the United States or to fossil fuel and renewable energy sectors. An environment that more than ever argues in favour of diversification within investment portfolios!
A quick look at the financial markets
- The Iran war is now into its fourth week, and it remains difficult to gain clear visibility on the duration of the conflict given Donald Trump’s repeated policy reversals and the resilience of the Iranian side! Oil and gas prices rocketed past $100/barrel and €55/MWh, with oil and gas facilities getting hit and passage through the Strait of Hormuz remaining very challenging. The conflict has inflicted the biggest supply disruption in the history of the global oil market, forcing producers around the Gulf to collectively shutter roughly 10 million barrels of daily output, according to the International Energy Agency.
- Nevertheless, equity markets have retreated moderately, with the MSCI World index down by about 5% (in EUR) since its recent top. The absence of heavy selling is striking. Only 8% of developed market stocks are technically oversold (compared with nearly 50% during the April 2025 market correction), a sign that profit taking has been narrow so far.
- Beneath the surface, a significant capital rotation is nevertheless taking place.
- It is still not clear whether the US can win the swift and conclusive victory it wants in Iran. It is very unclear what the future holds for Iran and its regime. In markets, however, there is clarity. So far, the winner of this conflict has been America, while most other regions have suffered: US equities have outperformed their non‑US peers by 6% (EUR) since early March, benefiting from the US being a net exporter of petroleum products!
- At the sectors level, fossil fuel and clean energy shares (solar, nuclear, …) and aerospace & defense stocks are rising, while stocks sensitive to energy costs and those linked to economic growth are facing profit-taking pressures. As in 2022, there is a rotation to stocks with low volatility, stronger balance sheets and steady earnings growth most common among defensive sectors.
- The key question for stock markets isn't the oil price; it is the duration. Since 1990, when oil remained above $100 for more than 30 straight days, forward returns fell to negative 6.4% over three months and negative 12.3% over 12 months.
- If capital flows are not massively turning away from stock markets, it is because the amount of oil required to produce goods and services has declined sharply in recent years. Moreover, market consensus is war won’t be long -- the futures market is pricing Brent crude at just over $80 by Christmas --, inflationary pressures will remain contained, and earnings forecasts will stay strong. Analysts are forecasting earnings growth of around 18% in 2026.
- That explains probably why investors have responded to the war in Iran with targeted profit taking and/or increased hedging, rather than turning completely risk off. But the longer the Strait of Hormuz stays closed, the more markets will have to factor in stagflation (weak growth and inflationary pressures) risks, potentially fuelling greater nervousness and volatility...
Our investment strategy
- ING’s portfolio managers are still pricing a conflict in Iran that won’t be long and that the issues in private credit aren’t systemic. But, at the same time, they don’t want to underestimate the knock-on effects of higher oil on fragile global supply chains.
- Given that the main risk for equities stems from the impact that rising oil prices and tighter financial conditions may have on earnings, and that the main risk for bonds lies in inflation, the funds managers prefer to avoid excessive directional bets by maintaining a neutral exposure to both equities and bonds.
- Sector-wise, they still recommend being as diversified as possible. It is preferable to focus on stagflation hedges (such as precious metals, renewable energy, infrastructure, real estate, or short-term inflation-linked bonds) and on sectors like healthcare, financials or technology, that have stronger pricing power, and which are less sensitive to rising energy prices.
- As bonds investors are growing uneasy about the potential cost of the Iran war, sending long-term government bonds yields higher, amid concerns over how the conflict will add to pressures on inflation, budget deficits and a potential hawkish response from central banks, ING remain underweight on sovereign bonds.
- The tensions observed in the private credit market, along with the disruptions triggered by artificial intelligence in the software sector, have also led to higher corporate bond yields (from 4.1% to 4.6% on average). Although financing conditions are tightening, it should be noted that they remain well below crisis levels (6.6% during the 2008–2009 financial crisis). Offering an attractive yield pickup over investment-grade credit and lower interest rate-sensitivity, high‑yield and emerging market debt remain favoured.
- Finally, commodities are beating stocks and bonds (+23% since the beginning of the year) in the most impressive way since the 2022 invasion of Ukraine! This is not surprising after history’s biggest ever shock to oil supply! Despite recent profit‑taking in gold, linked to a stronger US dollar and potentially less accommodative central banks, demand for gold remains robust. Gold funds have seen USD 6.2bn of inflows year‑to‑date. A prolonged war in Iran and rising stagflation fears could allow gold to reassert its safe‑haven role.