Conflict in the Middle East has reaffirmed that we live in a fragmenting world order, which demands extra vigilance from investors. Nevertheless, we believe fundamentals should be supportive of risk assets through the second half of this year.
Markets are growing accustomed to volatility as the first phase of the conflict in Iran draws to a close. They are starting to look through the short-term noise towards resilient fundamentals supporting asset performance through the rest of this year, while the AI capital expenditure (capex) cycle remains a powerful upward driver for markets across the globe. All of this results in a constructive environment for investors.
At the same time, an increasingly fragmented world order requires thinking about geopolitical factors in new ways. Traditional safe havens will not play the same role as they used to. And diversification will prove more important than ever (but harder to achieve).
With this in mind, we approach the second half of 2026 with the following top convictions:
- We are constructive on equity risk overall, but particularly in Japan and select emerging markets. We remain mindful of the strong rally markets have seen since April. We prefer to take risk in equities than credit, where spreads remain tight.
- AI capex has been the driving force for global markets and is supporting other themes like energy scarcity and grid upgrades.
- Commodities are boosted by geopolitical fragmentation and the AI capex cycle. Additionally, commodities, particularly those that are linked to energy, can provide useful diversification for geopolitical risk when traditional assets such as duration and gold behave less reliably,
Messy resolutions
The key macro variable for the near future is the energy supply shock caused by the closure of the Strait of Hormuz (Strait).
Our base case is for a ‘messy resolution’ to the conflict. Higher inflation and tighter monetary policy will drag on growth across most regions; energy markets will maintain a persistent geopolitical risk premium. Geopolitics will remain a pressing theme even if the US and Iran find a resolution, with question marks still hovering around the former’s intentions towards Cuba and Greenland.
The winners and losers will become clearer as different economies feel different effects from higher energy prices.
Source: Fidelity International, May 2026
Parts of Asia will feel this squeeze most, since countries here are particularly reliant on supply through the Strait.
Europe too is relatively exposed. We think the European Central Bank is the most likely of the major central banks to hike rates this year as higher energy prices and their second-order effects force a reaction. The conundrum for policymakers is that growth in Europe is also under strain, as higher energy prices erode real incomes and weigh on confidence.
The US should prove relatively resilient against the energy shock because it’s less reliant on imported energy. All the while the AI capex cycle continues to support the economy, feed into strong corporate balance sheets, and drive earnings momentum.
However, the US is also beginning to see the direct impact of the energy shock feed through to headline inflation. There is a risk that sustained energy costs begin to influence expectations and pricing behaviour. If the war re-escalates, more rate hikes by the US Federal Reserve (Fed) could be priced in. Private credit presents risks too, which we cover below, and those could prompt a swift policy response (with November’s midterms providing a potential flashpoint).
Against this backdrop, the scope for the Fed to ease this year will be limited. Policymakers will most likely remain cautious in the face of above-target inflation, with Federal Open Market Committee (FOMC) members likely to blunt new Fed Chair Kevin Warsh’s more dovish instincts.
A constructive environment
Resilient fundamentals are supporting markets, despite geopolitically induced volatility. Most significantly, US tech behemoths are continuing to pour billions into AI development that is driving continued earnings momentum.
That immense capex spend is bolstering companies across the value chain, including the industrial enablers that support the building of datacentres and rising energy needs.
A wider set of US businesses are also starting to feel the impact of that AI-driven capex spend underpinning earnings and improving productivity. This broadening effect across the market presents enticing entry points while attention is focused on a small number of high-valued tech names.
The earnings story remains strong globally, driven in part by AI capex, but also due to the partial unwinding of trade tariffs and resilient economies. Other structural themes will persist elsewhere, with Europe still investing in its defence sector, for instance, as conflict continues and policymakers strive to localise defence supply chains. Similarly, there is renewed focus on improving energy resilience, resulting in further investment by the US and Europe in their ageing grids.
The emerging markets split
That uncertainty also means it’s important to be selective when allocating across regions. We are underweight European equities, which are more exposed to supply disruption and the prospect of stagflation. Meanwhile the AI trade and strong earnings are supporting US stocks, though parts of that market have already run a long way. Japanese equities continue to look attractive, with earnings strong and the policy backdrop favourable.
Emerging markets (EM) remain a high conviction allocation for us. EM equities benefit from broader tailwinds such as the AI cycle. A softer dollar and structurally improving policy credibility should also be positive drivers.
However, the conflict in Iran is having a divergent impact across the EM universe. Those that export commodities in Latin America are benefitting; those that import energy, particularly Asian economies that are reliant on supply that passes through the Strait, are suffering.
So, a discerning approach by EM investors is required. Brazil for instance is one beneficiary from increasing energy prices with equities that are attractively valued and could do even better from an easing policy cycle. South Africa boasts attractive domestic fundamentals and commodity support. Parts of Asia Pacific too are compelling despite energy disruption - Korea, supported by the semiconductor cycle and corporate reform momentum, is one such example.
Rethink safe havens
As the macro environment changes, so does the way we think about diversification. Heightened geopolitical and fragmentation risks are putting a strain on traditional safe havens, which means investors can’t rely on a single asset to support riskier elements of their portfolio. We have moved from a world that was defined by occasional growth scares into one of more structural instability. Varied sources of defence are necessary.
The US dollar, for instance, does not look as attractive for the long term as it once did, owing to more erratic US policymaking. Gold has performed surprisingly poorly through the conflict, but we remain positive on the commodity, owing to its supportive underlying drivers. It can perform strongly when inflation hurts bonds and serves as a diversifier when correlations between bonds and equities increase. Likewise, it can respond well to dollar weakness and falling real yields.
Safe-haven assets perform differently across market sell off regimes
Past performance is not an indication of future results.
Source: Fidelity International, Bloomberg, April 2026. Based on weekly returns from January 1977 – April 2026. Dollar: DXY Index. UST: returns implied from the 10y US Treasury index. Oil: Generic 1st Crude WTI, backfilled with Bloomberg Commodity index prior to 1990. Gold: XAU Currency. JPY: JPYUSD Currency. CHF: CHFUSD Currency. Equities: MSCI World Index, backfilled with S&P 500 Index prior to 1999.
Exposure to commodities should support portfolios with inflation set to remain higher for longer, particularly those with energy exposure that can protect against geopolitical risk. They can also provide a hedge while duration suffers. Inflation reduces the scope for yields to fall materially and therefore diminishes the upside for duration, hence its poor recent performance. Were growth fears to re-emerge later in the year then duration would reprise its role as an equity hedge.
We’re similarly cautious on credit as spreads still offer limited compensation for the macro risks. High yield is more attractive than investment grade, particularly in the shorter and higher quality ends, though primarily as an income asset. Fundamentals are strong but offer limited scope for capital appreciation.
Finally, there’s private credit. The asset class has come under pressure recently, mostly driven by a shift in the credit cycle towards higher default rates. But defaults are increasingly concentrated in specific parts of the market, and certain sectors like software and technology lending are of greater concern.
The overall picture for private credit is one of contained rather than systemic risk, with fundraising and fundamentals still healthy. More defensive areas such as mid-market lending with stronger covenants, experienced managers, and diversified asset-back lending, appear best placed to weather the near-term disruption.
Through the noise
Markets have proven impressively resilient against a volatile first six months of this year. But their steadfastness shouldn’t be surprising. They’ve become well-versed in seeing through the noise and recognising upside. An immense AI capex cycle, strong earnings and relatively strong fundamentals across markets have reassured investors that there’s still plenty of alpha to be captured.
Now is not a time to shy away from risk; only to ensure it’s balanced in a well-diversified portfolio that will cushion the inevitable shocks when they come.
