Oleksii Liskonih
Beware of an upswing in volatility in the equity and commodities markets should the latest and “dangerous” Middle East conflict escalate, Wells Fargo Investment Institute said in outlining three portfolio moves investors may consider after Iran attacked Israel over the weekend.
Iran launched a missile strike against Israel on Saturday in retaliation to a suspected Israeli attack on Iran’s embassy in Syria on April 1. The attack caused no deaths and sparse damage due to the air defenses and countermeasures of Israel and its allies, and Iran signaled that it deemed the matter closed. Several world leaders and major governments urged Israel against escalating the matter.
A third meeting of Israel’s war cabinet would be held on Tuesday to decide on a response to Iran, Reuters reported earlier, citing an Israeli government source.
“The initial negative reaction across commodity and equity markets quickly turned mostly benign, but our view is that this latest escalation poses greater risks for potential future capital-market volatility,” Paul Christopher, head of global market strategy at Wells Fargo Investment Institute (WFII), said in a note on Monday.
A key risk toward a sudden escalation in the conflict, with accompanying market volatility, is that either Iran or Israel may add direct attacks to its strategy, Christopher said. Also, Iran’s latest attack may have been probing Israel’s aerial defense system’s response. “Iran may at some point attempt a more complex, multidirectional attack to confuse or overwhelm that system,” the strategist wrote.
With the potential for conflict escalation and increased volatility, WFII said it preferred a quality focus in portfolio allocation and suggested investors undertake three steps:
- Rebalance: Investors should consider rebalancing risk to target levels. WFII suggested trimming the Information Technology and Communications Services sectors as they “look expensive” from a price-to-earnings perspective. Tactical allocation may call for rebalancing into Wells Fargo’s favored sectors of Industrials, Materials, Energy, and Health Care from tech-related funds or positions. Long-term investors may seek to reallocate to short-term fixed income. After the S&P 500’s (SP500) five straight months of gains, a portfolio’s balance between stocks and bonds may have increased equity risk by more than originally desired, WFII said.
- Prepare for likely volatility in fixed-income markets: An unexpected event may lead to a temporary delay in the resumption of disinflation. That makes short-term fixed income more appealing than holding cash and investment-grade intermediate- and long-term bond positions close to long-term target allocations preferable. Also, a portfolio should not be underweight to strategic targets in intermediate-term fixed income.
- Consider commodities to help diversify: WFII favors a commodity allocation for long-term investors, including a small allocation for income-oriented investors. For tactically oriented investors, overweighting commodities could be a good way to hedge further geopolitical risk, it said.
