Geopolitics & Energy: Fragile And Unsolved

The macro landscape over the past few years has been shaped by a steady succession of shocks, ranging from inflation and sharply higher interest rates to geopolitical conflicts and tariffs. Although each episode presented substantial risks and uncertainties, the world economy has thus far absorbed these setbacks without falling into a downturn. The post-pandemic expansion, now in its sixth year, has proven exceptionally durable, though repeated disruptions may be leaving the cycle more sensitive to new shocks.

The latest challenge is a sharp rise in energy commodity prices stemming from the U.S.-Iran impasse. At present, the primary concern is whether the current disruption proves temporary or evolves into a more prolonged supply imbalance. Without a diplomatic breakthrough that reopens the Strait of Hormuz, energy markets may become significantly undersupplied over time as inventory buffers diminish. In that scenario, the risk of renewed upward pressure on oil prices and inflation would rise materially while simultaneously dampening growth, particularly as seasonal energy demand strengthens into the summer travel months.

U.S.-China Relations: Strategic Stability

President Trump’s visit to Beijing produced a constructive shift in tone between the U.S. and China. Both sides described the meetings favourably, with China framing the relationship as entering a period of “constructive strategic stability”. Discussions reportedly included Chinese purchases of U.S. aircraft, agricultural products and energy, along with possible U.S. adjustments to tariffs and technology export controls.

The details remain under negotiation, leaving investors cautious about what will ultimately be implemented. More significantly for markets, the meetings did not appear to deliver much progress on enlisting China’s help to reopen the Strait of Hormuz.  Still, the near-term benefit is that the trade truce should continue, reducing the risk of another escalation between the world’s two largest economies.

Earnings Season Draws to a Close

The nearly completed U.S. first-quarter earnings season has provided important fundamental support for equity markets. After declining in March in response to the U.S.-Iran war, U.S. equities have rebounded and are now up roughly 8% year to date. Reduced fears of a worst-case Middle East scenario aided sentiment, but it is earnings that have done much of the heavy lifting.

Corporate results broadly exceeded expectations, and forward profit estimates have continued to move higher. However, profit momentum remains uneven. Technology and AI-linked companies continue to drive much of the uplift in earnings expectations, while the energy sector has been boosted by higher commodity prices. That concentration is not necessarily a concern as long as financial results continue to validate it. But with valuations largely reflecting a favourable outlook, markets will likely need continued earnings delivery to sustain upward momentum.

Rising Bond Yields

Global bond yields have risen meaningfully in recent months, as markets have reassessed the path for inflation and central-bank policy following the oil price shock. The U.S. 10-year Treasury yield has risen by about half a percentage point since late February, reaching 4.56% at the time of writing, while the Canadian 10-year Government of Canada yield has risen by a similar amount to 3.58%.

When inflation pressures rise, bond yields tend to adjust upwards to reflect a more uncertain outlook. For investors, the increase in bond yields has created near-term downward pressure on bond prices, but it has also improved income opportunities moving forward. For equities, higher bond yields can be absorbed reasonably well when growth remains resilient even if inflation risks become more prominent. Although we believe today’s backdrop includes elements of both, we are mindful that higher borrowing costs could potentially pose a risk to household spending, a crucial pillar of the economy.

Takeaway

Despite uncertainty around energy markets clouding the macro backdrop, corporate fundamentals have continued to provide an important source of support for risk assets. Positive earnings momentum and strong business investment have helped equity markets digest a sizeable increase in bond yields this year. Nevertheless, since profit growth ultimately depends on stable economic conditions, we remain attentive to the possibility that a prolonged energy supply disruption could create more meaningful headwinds in the months ahead. In our view, portfolios should remain invested in equities in line with long-term target levels while maintaining diversified exposures to navigate a wider range of outcomes.