Weekly Comment: Unpredictable capital flows and how to tackle them

Market overview

Oil and gas prices soaring, global stock markets in risk-off mode, US dollar climbing—as war in the Middle East enters its third week, markets appear to be behaving as one might expect. The near 50% rise in the price of oil since 27 February, reflects the loss of up to 20% of global production as a result of the effective closure of the Strait of Hormuz. Stock markets in retreat, pricing in the adverse impact a prolonged war would have on global growth and inflation. The higher dollar, demonstrating that the greenback is still viewed as a safe haven despite some recent reports to the contrary. But scratch beneath the surface and not all areas of the market are behaving quite as one would expect.

Take gold, a go-to in times of conflict and uncertainty. Not so this time, at least for now. The price of the yellow metal is down from around US$5,200 on 27 February, the day before war broke out, to around US$5,000 at the time of writing. A number of factors could be at play here: gold’s stellar run over the past few years; concerns a prolonged inflationary shock could see interest rates rise (higher interest rates increase the opportunity cost of holding gold); and the ‘retailification’ of the gold trade —retail investors possibly having to liquidate profitable gold positions to offset losses elsewhere.

And then there is stock market performance at the sectoral level. As a general rule, certain sectors are better placed than others to weather periods of uncertainty. Companies selling must-have goods and services, for example, tend to outperform those selling nice-to-haves. It follows that sectors such as telecoms, consumer staples, utilities and healthcare typically rise to the top of the performance charts when there are economic growth concerns, while growth and economically sensitive stocks often sink to the bottom. This time round, however, the winners and losers are not so clearly obvious with consumer staples and healthcare among the worst performers and consumer discretionary among the better performers.

Between 27 Feb and 11 March, tech was up 1.5%. Quite a turnaround for a sector which prior to the war was among the weakest owing to concerns over the billions being spent on artificial intelligence (AI) and the threat posed by AI to software companies’ business models. Tech companies with their relatively low energy needs and strong profitability, suddenly the defensive dish of the day then. Or are they?

For the same Financial Times article suggests tech’s outperformance is down to investors, such as hedge funds, closing short positions taken out prior to the war—between February 27 and March 5, technology was “by far the most net bought global sector” which, according to a Goldman Sachs report was “almost entirely driven by risk unwinds/short covering”.

Like gold then, technology’s performance (to date) could be down to investors unwinding positions. Question is, once these investor capital flows run their course, and depending on the duration and severity of the conflict, will the performance of gold and information technology mean revert? Just one of the many unanswered questions thrown up by the Middle East conflict. To the list of risks then can be added getting caught up in the unexpected consequences of unpredictable investor capital flows.

Against such a backdrop, we continue to advocate a strategy centred around holding portfolios that are diversified at asset class, sectoral and geographic levels, maintaining a long-term perspective and avoiding knee-jerk reactions as the best way to manage risk.

Weekly market moves and economic news:

The MSCI All Country World Index (MSCI ACWI) ended the week down 1.7%, pushing year-to-date (YTD) performance into negative territory (-1.2% YTD).

United States:

With no end in sight to the war in the Middle East, the main US stock market posted a 1.6% loss for the week (-2.9% YTD).  Not much separating the performance of growth (-2.0%) and value (-1.4%) stocks, although on a YTD basis, growth stocks remain the clear losers (-7.3%) compared to value (+2.1%). Small caps are now almost flat for the year (+0.2%) after a weekly decline of 1.4%.

US Treasury yields continued to tick higher, reflecting the view that inflationary pulses unleashed by the war are increasing the likelihood that the next rate cut will be pushed out to as far as 2027. The yield on the 10-year Treasury note ended 14 basis points higher at 4.28% (up 11 basis points YTD), while the 2-year note yield rose 16 basis points to 3.72% (up 24 basis points YTD).

The ongoing conflict means economic data releases have been taking a back seat. However, for the record, February’s headline consumer price index (CPI) print showed prices up 0.3% month-over-month (MoM) and 2.4% year-over-year (YoY). Core CPI, which excludes food and energy, rose 0.2% MoM and 2.5% YoY. Sticking with inflation, the core personal consumption expenditures (PCE) price index came in at 3.1% on an annual basis, the highest it has been since early 2024. And there was a downwards revision to US GDP growth in the fourth quarter from 1.4% to 0.7%. Lower exports, weaker consumer and government spending, and softer investment were all cited as reasons for the downgrade.

United Kingdom:

Despite the ongoing conflict and a lower-than-expected economic growth number for January—flat compared to expectations of 0.2% growth—London’s large caps ended the week roughly where they began, leaving the 4% YTD gain intact. The more domestically oriented mid-caps appear to have felt the disappointing January growth figure more keenly, finishing the week down 1.9% (-1.4% YTD).

Government bonds seem to be more concerned with the threat of inflation and the prospect of higher interest rates than the disappointing growth figure.  The yield on the 10-year UK gilt added 19 basis points to 4.82% (up 35 basis points YTD). Sterling lost ground against the US dollar, ending the week at US$1.32 compared to US$1.34 previously.

Europe ex UK:

The MSCI Europe ex-UK Index was left nursing a modest weekly loss of -0.5% (-0.2% YTD). As with elsewhere, the war in the Middle East and its potential impact on inflation and growth rather than prior economic data dominated sentiment. At the national level, Germany’s main market finished 0.6% lower (-4.3% YTD); France’s ended down 1.0% (-2.9% YTD); Switzerland was not far behind with a 0.9% loss (-2.2% YTD); while Italy was the outlier with a +0.4% gain (-1.1% YTD).

The yield on the 10-year German Bund climbed 12 basis points to 2.98% (up 13bps YTD) as European Central Bank President Christine Lagarde stressed the central bank will take the necessary steps to keep inflation under control. Finally, as with sterling, the euro weakened against the US dollar to US$1.14 compared to US$1.16 previously.

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