Dear Investor

General Market Overview

While the S&P 500 was positive over the quarter, global markets, particularly tech-heavy indices, have been driven by sentiment towards Artificial Intelligence (AI) of late. There are “disintermediation” fears that build on the idea that self-improving AI speeds up the timeline for AI replacing human labour, creating widespread job losses. The other current concern is the vast sums of CapEx (Capital Expenditure) being spent on AI by the major computing firms, or “hyperscalers,” which are consuming company free cash flows and removing that money/liquidity from the market. CapEx spend reduces dividends and stock repurchases, potentially leaving those firms to rely more heavily on debt. Alphabet (Google) recently issued a rare 100-year century bond, raising over $1 billion to help finance large AI and data centre plans.

Historically, major technological shifts have expanded total economic output – increasing the size of the pie – rather than merely rebalancing labour and capital intensity. For example, the Industrial Revolution, beginning in the late 18th century, exemplifies a technological shift that dramatically expanded economic output through innovations such as the steam engine and mechanised factories, boosting production capacity and leading to sustained Gross Domestic Product (GDP) growth rather than merely reallocating resources.

Similarly, the advent of electricity in the late 19th and early 20th centuries vastly improved manufacturing efficiency and spawned entirely new sectors, such as electrical appliances and modern assembly lines. More recently, the digital revolution, particularly the widespread adoption of computers starting in the late 20th century, expanded global economic output by enhancing productivity and creating new digital economies, such as software, e-commerce, and data-driven services. While historical precedent doesn’t guarantee a future trajectory, AI will likely unlock new industries and opportunities we can’t yet fully appreciate. However, this uncertainty is pushing market sentiment quite wildly in both directions, creating fairly volatile equity market performance.

The other recent driver of market sentiment was President Trump’s nomination of Kevin Warsh as the new Federal Reserve (the Fed) Chair, to succeed Jerome Powell, whose term ends in May. The appointment has raised concerns about the Fed’s independence following Trump’s recent, escalating attacks on Powell for not cutting interest rates quickly enough.

The Fed has two decision-making bodies, the Federal Open Market Committee (FOMC) and the Board of Governors. Kevin Warsh would be one of 12 members of the FOMC, which votes on the key policy rate and on quantitative tightening versus easing (balance sheet contraction or expansion). As the Chair alone does not set interest rates, concerns about the Fed’s overall independence in setting interest rates are likely overblown. However, the Chair does control how the Fed communicates.

Deutsche Bank’s United States (US) economists believe that if Kevin Warsh is appointed Fed Chair, he will move away from the quarterly Summary of Economic Projections (including the dot plot) and instead provide a variety of scenarios without offering explicit guidance. Shifts in transparency (press conferences, forward guidance) can materially affect how the market prices uncertainty. Currently, Warsh’s potential communication style is unknown, which creates market uncertainty.

The other key risk to global markets and the global economy is escalating Middle East tension. On the 28th of February, the US and Israel launched a major assault on Iran in which President Trump said that the US-led operation would seek to eliminate Iran’s nuclear and missile programs, destroy the country’s navy, and change its leadership.

In a fast-evolving situation, Trump reported that Iranian Supreme Leader Ayatollah Ali Khamenei was dead. In contrast, Iranian media maintained that Khamenei was alive and “steadfast and firm in commanding the field.” The Iranian media later confirmed the death.

Iran has since retaliated, firing missiles at Israel and US military bases in multiple Gulf states. The governments in Bahrain, Kuwait, Jordan, Qatar, and the United Arab Emirates (UAE) all said they have been targeted. No one in any leadership position within the Middle East will likely lament the passing of the Iranian regime should the Islamic Republic fall. Doha has had better relations with Iran than other Gulf states, but Qatar issued a strong condemnation of Iran’s retaliatory strikes on its territory.

From a global trade perspective, a critical energy “chokepoint” is the Strait of Hormuz. It is a narrow waterway between Iran and Oman and is the sole sea exit from the Persian Gulf to the open ocean. Approximately 20% of global seaborne oil trade passes through the Strait, as does a significant share of Liquified Natural Gas (LNG). Major exporters that rely on it include Saudi Arabia, Iraq, the UAE, Kuwait, and Iran itself.

In response to the strikes, Iran’s Islamic Revolutionary Guard Corps (IRGC) issued VHF radio warnings to vessels declaring the Strait off-limits or unsafe for transit. Brent crude is already up about 20% year-to-date, and a “worst case” multi-day (or week)- long disruption could push oil to over $100 per barrel, or even $150 in some scenarios. In addition to a spike in oil prices, the cost of shipping oil through the Strait could also jump significantly. The Financial Times reported that major insurance companies are preparing to cancel coverage policies or materially raise premiums for vessels operating in the Persian Gulf.

General Conclusion

It is currently unclear how long or how severe the current Middle East conflict will be. At the time of writing, the major travel hubs of Dubai and Doha are closed, creating chaos with stranded passengers, aircraft, and crew worldwide. Also importantly, many cargo flights pass through those terminals, and there will be a knock-on effect on the logistics industry.

The oil price will, undoubtedly, react sharply to the conflict, and that move will feed into a wide range of financial and real assets. There is also likely to be a “risk off” correction in financial markets, in which liquid, high-beta assets suffer the most. Current events are a major sentiment mover, and the resulting volatility will likely persist for some time.