Short-term pain, long-term gain

Markets swung wildly on Monday morning after a dramatic U-turn from President Trump reversed early losses in bond, equity and precious metal markets.

Investors regained their composure after a Truth Social post from Donald Trump put on hold his earlier threat to attack Iranian power networks if the Strait of Hormuz were not re-opened to shipping by midnight tonight.

Until the White House’s apparent change in direction, investors had been looking in vain for safe havens as tensions mounted in the Middle East. Bonds, shares and precious metals had fallen in tandem as we entered week four of the Gulf conflict.

But investors continue to sit on sizeable gains over the past three years. And the change in direction on Monday morning confirms that there is a reluctance to give up on a market that continues to be well-supported by earnings and where a quick resolution of the crisis offers the possibility of a sharp rebound in prices.

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No port in the storm

The change in direction in markets represented a big relief rally after a sticky start to the week. In particular, the traditional role of bonds as a diversifier in a balanced portfolio has been undergoing a stress test this month.

With constrained energy supplies representing the greatest inflationary threat to the global economy in 50 years, rising interest rates present a significant and simultaneous headwind to both shares and bonds.

Bond yields are rising around the world, but nowhere more so than here in the UK. The 10-year government bond yielded just over 5% on Monday morning, the highest since 2008. Since the Middle East conflict began at the start of March, the 10-year yield had risen by 0.8 percentage points. It’s the worst month for bonds since the mini-budget crisis of 2022.

Yields are up elsewhere too. The US 10-year bond yields 4.4%, up from 3.95% pre-crisis. German bonds are yielding 3.05%, up from 2.65%. Bond yields move inversely to bond prices.

Rising yields reflect growing fears of stagflation. That’s a challenge for policy makers because high inflation prevents the Bank of England from cutting interest rates to support a weaker economy. For the government it raises borrowing costs, even as tax revenues slow on the back of stagnant growth.

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Shares track bonds lower

Stock markets also entered the fourth week of the crisis on the back foot as Donald Trump laid down a 48-hour deadline to Iran to re-open the Strait of Hormuz. Iran is showing no sign of complying. It threatens retaliation if, as promised, the US hits its power networks. The Monday social media post seemed to take that scenario off the table - for now at least.

But not before, it had dragged stock markets lower. Asia was hard hit, with big energy importers such as Japan and Korea most impacted. Korea’s Kospi fell around 5% on Monday and Japan’s Nikkei was more than 3% down. The change of direction came too late for Asian markets, which had already closed.

Europe fared a bit better, but shares in Germany were off nearly 2% and the UK’s FTSE 100 was 2.5% down. Within minutes of the suspension of the threat, however, the UK benchmark was back in positive territory.

The US is relatively protected as a major oil and gas exporter, and it is supported by still rapidly rising corporate earnings. But it has still lost around 5% since the start of the conflict.

Gold loses its lustre

Gold is often viewed as a safe haven at times of geo-political uncertainty and a hedge against inflation. After a strong run in recent years, however, investors are choosing instead to focus on the precious metal’s lack of income in an environment of rising bond yields on other assets like cash and bonds.

Gold fell by around 8% on Monday to a recent low of under $4,300 an ounce. That compares with a high earlier in the year of $5,500. The metal has fallen in nine consecutive sessions as it fails to live up to its port in a storm reputation. Silver has fared even worse. The current price of $65 an ounce compares with a recent peak of over $100.

Short pain, long gain

Investors are nursing painful losses in the short term, but they continue to enjoy longer-term gains. Since markets bottomed out in October 2022, stock market indices have registered big rises.

The MSCI emerging market index, for example, bottomed out at 845 in 2022 and recently hit a high of over 1600. Despite falling back this month to 1470, it has enjoyed a rise of more than 70% since its low point just over three years ago.

Other markets have enjoyed similar trajectories. Japan’s Nikkei 225 index has more than doubled since the start of 2023. The MSCI World index is 75% higher than its 2022 low.
What has changed this month has been the market leadership. The US has returned as a relative safe haven during troubled times.

Over the 14 months from the start of 2025 to the end of February, the S&P 500 delivered a 17% return. That was around half the return from the FTSE 100 and just a third of the gain enjoyed by investors in emerging markets and Japan. Europe did twice as well over that period as the US.

But over the past month that leaderboard has been turned on its head. The US was down 5% from the February peak at the end of last week. But that compared with a 9% fall for the FTSE 100, similar to the declines reported in Japan and emerging markets. Europe was 12% lower.

The swing in relative performance makes a strong case for holding a diversified portfolio - geographically if not, at the moment, by asset class. A good spread of investments can provide a smoother ride over the longer term.

And the rapid shift in markets at the start of this week makes a further case to avoid the temptation of trying to time the markets. With events in the Middle East so unpredictable, investors risk being whipsawed by dramatic reversals in sentiment.

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• Read: How this market wobble compares
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• Read: Where next for interest rates?

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of financial adviser or an authorised financial adviser of your choice.