Introduction
The recent escalation in the Middle East has introduced a classic stagflationary impulse into global markets, simultaneously exerting upward pressure on inflation expectations while tempering growth forecasts. As we enter the third week of the conflict, the investment landscape is defined by "duration uncertainty"—regarding both the length of the U.S.–Iran hostilities and the persistence of energy supply disruptions.
Implications for NJR Partners' Investment Principles
Current sentiment in the equity complex is pessimistic. High put-skew and negative sentiment indicators suggest the "downside tail" is heavily priced. However, the fundamental risk to global growth remains acute if the Strait of Hormuz remains contested, potentially forcing Brent crude to maintain a premium above $100/bbl ($104 at the time of this post).
Further, the "creative destruction" within the AI sector continues to weigh on multiples, particularly in software and hardware. While the long-term theme remains intact, we are observing a necessary derating of software and hardware names. Our recent additions to the Vanguard FTSE Pacific (VPL), FTSE Europe ETF (NYSE: VGK) and Vanguard S&P 500 (VOO) provide broad-based exposure, and we remain vigilant regarding the concentration of technology multiples within these indices. This action is consistent with our Constant Risk Budget principle because we were slightly under our 75% Equivalent Equity Exposure risk target.
We also note a challenge to the Correlation Assumptions previously held by the market. The prior view of "long front-end rates" as a cheap hedge for risk portfolios failed during this energy shock, as yields rose alongside equity volatility. We also note that long-term rates rose sharply, particularly in Europe, challenging classic 60/40 portfolios. This reinforces the case for maintaining a dedicated Tail Risk allocation rather than relying solely on traditional fixed-income duration or cash for capital protection.
The current supply-demand imbalance in LNG and Crude is a stark reminder of the benefits of diversification. We have belatedly commenced allocating to Commodities in order to align with the NJR Partners Custom Benchmark commodities exposure (1.5%) and to hedge against inflation risks from supply constraints.
Private Credit is attracting some negative headlines. Our managers report strong fundamentals in their portfolio companies.
Proposed asset allocation rebalance actions
- Commodities: Execute phased entry into Invesco Bloomberg Commodity ex-Agriculture (XAAG:TH) to reach the 1.5% benchmark target, providing a direct hedge against energy duration risk.
- Tail Risk: Maintain overweight Tail Risk and high liquidity levels
- Equities: Continue to diversify with allocations to Japan, the pacific and Europe
- FX: Fund equity allocations in USD to reduce overweight USD currency exposure
- Gold: Maintain overweight despite recent price action and increased inflation concerns.