By Evan Mancer, CFA
The outbreak of the Iran war unsettled markets and caused most major equity indices to fall. Germany’s DAX 40 dropped 7.4%, while America’s S&P 500 declined by 4.3%. France’s CAC and Australia’s ASX slid 4.1% and 1.9% respectively. A few markets still managed positive returns: the S&P/TSX eked out a gain of 3.9%. Japan’s Nikkei 225 and Britain’s FTSE followed close behind at 3.8% and 3.3%.
How should investors interpret the war in Iran? Our answer (as is often the case) is to stay invested. While it is easy to imagine the war getting worse as both sides escalate pain points to gain leverage, we do not believe the US or Iran has any appetite to get into a multi-year war.
And even in the case of more drawn-out wars, history suggests that markets are more resilient to military conflict than headlines imply. Annualized returns during the Israel–Hamas war and the ongoing conflict between Russia and Ukraine were 29.5% and 12.9%. Even the second world war saw annualized returns of 13.9%. Where wars have coincided with market weakness, such as during the Vietnam war, broader economic forces, such as stagflation in the 1970’s, did most of the damage.
The economic force having the biggest impact today is artificial intelligence. The current cycle has reinforced a shift already under way: returns are spreading from the big technology firms funding much of the spending towards the less glamorous companies building the infrastructure that enables it, such as utilities, industrials and pipeline companies.
We are becoming somewhat less concerned about AI-driven unemployment, despite many companies announcing layoffs. The pessimistic argument is simple enough: if AI doubles productivity, firms will need only half as many workers. But this assumes demand is fixed. Already, new AI start-ups are proliferating, while established firms are racing to adapt their business models.
The greater challenge may be the pace of change. The software industry is the best example today. Over the past year, many software firms with solid growth records have lost more than half their market value, as investors fret that AI could destroy business models. Our view is that demand for software will grow over the coming decade. But how it is developed, priced and distributed almost certainly will change. Our approach is to focus on companies that broadly benefit from AI spending while also maintaining core businesses that deliver healthy growth on their own.
Meanwhile, the One Big Beautiful Bill should provide a near-term boost to consumer spending as tax refunds in the U.S. will be significantly higher than usual. This should help sustain consumption by U.S. consumers despite higher prices at the pump while also having positive spillover effects to Canada and Mexico.
Oil prices surged by 76% in the first quarter, reaching $103 a barrel, after Iran attempted to close the Strait of Hormuz to exert economic pressure on the US. Prices have since eased to around $97, though volatility remains extreme; intraday highs have touched $119. We believe this war will be finished before US midterm elections in November and that this will result in lower oil prices a year from now than today. But supply constraints complicate the picture. Storage across the Gulf has reached capacity, forcing producers to shut in wells. Restarting wells involve technical issues that will likely delay a full recovery in output for up to two years. As a result, our long-term oil price range has shifted higher, from $60–80 to $70–90 a barrel.
Currencies, meanwhile, have been dull by comparison. The Canadian dollar ended the quarter around $0.72, down from $0.73 three months earlier. Interest rate cuts will likely be on pause in both Canada and the US as central banks wait to see the extent that higher oil prices affect inflation and unemployment. Relative to the size of its economy, Canada is a much larger energy exporter than the U.S., which should be positive for the Loonie this year.
