The Iran war has upended long-held assumptions about how asset classes behave, Paolini said. Bearish developments for equities tend to support bonds, but both are struggling simultaneously, leaving investors with few places to hide and no obvious safe harbour. “US President Donald Trump’s unpredictability makes it impossible to take a rational view of markets over the coming weeks,” he said in a note.  As he cannot gauge how or when this conflict will end, he is taking a neutral stance across equities, bonds and cash.

While the risks for Europe and some emerging markets are well flagged given their dependence on oil imports, Paolini thinks that the US is not immune to the oil shock: prices are global, and the economy was already slowing ahead of the conflict. He expects US inflation to run at 3.3 per cent this year against a consensus of 2.7 per cent, and growth of 2.0 per cent versus market expectations of 2.5 per cent – a stagflationary combination.

Equities
Paolini has moved most equity allocations back to benchmark. China is the exception – substantial commodity stockpiles, alternative energy supplies and supportive fiscal and monetary policy set it apart, so he remains overweight.

Although a number of investment managers – for example, Edmund Shing, global chief investment officer at BNP Paribas Wealth Management – remain quite positive about emerging markets, Paolini believes that, outside China, emerging-market (EM) equities appear more vulnerable. In his analysis, a 50 per cent rise in oil prices lasting four months would deliver a damaging economic blow to net oil importers such as Thailand, Korea, India and South Africa, weighing on GDP growth and external balances. At the same time, a broad appreciation of the dollar would tighten financial conditions in these markets, as it raises imported inflation and encourages capital outflows. Against this backdrop, Paolini has reduced his emerging market equity allocation from overweight to neutral.

As part of a defensive sector allocation shift, he has upgraded utilities which benefit from stable demand across economic cycles and in volatile markets, and are set to gain additional impetus from electrification and policies aimed at energy independence. He maintains an overweight stance in healthcare and has downgraded consumer discretionary stocks to underweight as any spike in inflation would weigh on real incomes and discretionary spending.

His overweight stance in technology remains unchanged. The recent correction in these stocks has brought valuations down from expensive levels, while AI-related investment in data centres and digital infrastructure – expected to total around $600 billion this year – should continue to support demand for hardware and semiconductor companies.

Fixed income
Paolini said fixed income is not offering any shelter, with stagflation risk driving bonds and equities lower in tandem. He has moved US Treasuries from underweight to neutral, with yields already having risen and the US Federal Reserve’s dual mandate limiting scope for further sell-off. He has also reduced emerging-market local currency sovereign and corporate debt from overweight to neutral.

He has trimmed gold from overweight to neutral. The precious metal has fallen by around 15 per cent since the conflict as central banks that have accumulated large profits from their gold holdings have sold some of their reserves to fund additional spending on energy and defence. On currencies, Paolini has increased Japanese yen to overweight due to government support and retained above-benchmark Swiss franc exposure as his preferred defensive hedge.