Key Takeaways
- Markets look set to remain volatile as the US-Iran ceasefire deal evolves, with oil prices likely to remain above pre-war levels for some time.
- China offers opportunities should the conflict flare up again, while European equities and bonds could benefit if the ceasefire holds.
- The US midterms, global growth and AI remain among key risks through 2026, even as the war dominates markets.
Karen Gilchrist: The ripples from the conflict in the Middle East continue to dominate the market narrative. Global assets have been under pressure and energy disruptions look set to endure well beyond any ceasefire. To discuss navigating volatile markets, I’m joined by Luca Paolini, chief strategist at Pictet Asset Management.
Now, Luca, you’ve expressed skepticism over markets’ reaction so far—or indeed their lack thereof—in the early weeks of the war. You’ve now turned a little more sanguine on the news of the ceasefire. Tell me your rationale here and where you see markets going from here.
Luca Paolini: Well, first of all, let me say that we always respect market reaction. I think when you look at the ceasefire, we know there are a lot of areas where there is no clarity on exactly what is going to happen. What we know now, that Iran and the US are talking to each other, was not the case a few weeks ago. There is a clear indication that we are moving towards a de-escalation phase.
There will be still a lot of noise. A lot of tweets in the middle of the night. But the direction of travel, I think, is right. The market has reacted quite significantly. And our concern, in fact, is that the market—relative to previous shocks—has never been significantly oversold. There hasn’t been capitulation. So yeah, we are a little bit more optimistic about the outcome of this conflict. But, at the same time, we are also aware that the upside for equities especially is quite limited at this point in time.
Oil Prices to Stay Firmly Above Pre-War Levels
Karen Gilchrist: So a little bit more volatility going forward. Do you have any thresholds in mind or targets that you expect for, for instance, oil prices? Where do you think we could see them going in the coming months?
Luca Paolini: Well, realistically speaking, the oil price would probably fall a little bit from here, but it’s not going to be at the level of pre-war. I don’t think it is going to go back to USD 60 or USD 70. I think USD 80, USD 90 is probably a more likely scenario. And obviously that’s bad for the global economy, but it’s not as bad as it could have been. So I think, again, positive but we have to be aware that there are some risks on the global economy and inflation, which I think though could be quite limited.
China Presents Opportunity Amid War Volatility
Karen Gilchrist: Now, I’d love to come back to inflation. But first of all, I was fascinated to see that you highlighted Chinese stocks, or China in general, as an area of resilience in this war. Explain that thinking and where investors might find opportunities, potentially, if this conflict is to flare up again.
Luca Paolini: A lot of investors think that China is very vulnerable because China is a big importer of oil. The reality is that China has also a big coal industry. So there are different sources of energy that they can use. And also in terms of electrification, China is well ahead, for example, of the US. But also I think that China, in the past during crises, tends to work as a kind of safe haven.
We see that also in Chinese bonds, and the reason is because China has kind of its own political, economic and financial cycle. So even if China remains, obviously, a risky place to invest, when everywhere else is getting riskier, in relative terms China becomes a little bit safer. And that’s why I think Chinese stocks and bonds tend to do quite well in periods of market stress.
European Equities, Bonds to Gain Amid Ceasefire
Karen Gilchrist: Interesting. Where else are you seeing other opportunities and risks as you think about your positioning now that we at least have a ceasefire for now?
Luca Paolini: Well, I have to say that we see some upside potential in equities, especially in Europe, if this crisis comes to an end. We also start to think that there is value in bonds because, you know, you still have two rate hikes priced in in Europe especially, which I think is not consistent with the growth picture that we have for Europe, which is still relatively weak.
Inflation will spike in the next couple of months, but if the oil price goes back to USD 80 and USD 90, obviously the inflation risk will go back to normal. So we think that the market is a little bit too worried about rate hikes at this point in time. It should support bonds in the short term. So I think we are increasing a little bit our duration. We start to like a little bit more European stocks. But again, the upside for equities, I think, is quite limited even after the good news of the last few days.
Rate Hikes Bets Overdone Even With Inflation Uptick
Karen Gilchrist: I’m glad you touched on inflation and central banks. It seems as though you’re not overly concerned about these inflation risks that many market watchers have been proclaiming in the in the early weeks of the war. So you think we continue to have a bit of a steady path and hopefully not too many hikes going forward?
Luca Paolini: Yes. I think typically we compare the current crisis with 2022 and Ukraine and Russia. It’s a very different macroeconomic scenario. Back then, employment growth in the US was 5% per annum and now it’s zero. We had negative real interest rates, now they’re positive. And also we were coming out of the pandemic with huge excess savings in the system. Now, it’s completely different.
Of course there is a risk of inflation, but we also think that this risk is contained because the growth picture is a bit weaker. So don’t get me wrong, there will be a spike in inflation. But I don’t think the central banks will react to this, what I think is a temporary spike, but not a long term risk to inflation.
US Midterms and Growth Among 2026 Risks
Karen Gilchrist: Now finally, of course, the Iran war has dominated markets lately. We’ve even had Trump come out now and make renewed remarks about Greenland. So obviously turmoil is set to continue through this year. But where, when you look beyond that, are some of the biggest risks and opportunities that you see in 2026?
Luca Paolini: Well, in terms of risk, a risk that I think few investors seem to mention is the midterm elections in the US. Now, we know that Trump’s numbers are not great. We know that the risk is that Republicans will lose control, even of the Senate. And this will create, of course, a huge problem for Trump. He won’t be able to push for his agenda. And this actually can have a significant impact on markets. Think about deregulation, tax cuts and all these kind of things. So this is one of the risks.
The second one, which I think is also a little bit not talked about too much, is growth. Because yes, if you look at the US, still 2% growth, Europe is okay. But let’s not forget that we come from a period of strong growth. And I do believe that when you look at especially the labor market in the US, Europe as well, there is a lot of weakness there. And on the top of this earnings growth. Expectations for 20% earnings growth this year and next, at a time where global growth will be weaker, I think that’s probably the major risk: A significant kind of downgrade in earnings expectations in the coming months.
AI to Continue Shaping 2026 Earnings
Karen Gilchrist: And of course, AI, I know, is another one that you’ve highlighted. Risk? Opportunity?
Luca Paolini: Both. I think in the long term we believe that AI is truly transformational. I think productivity will go up and this will support all, basically, companies and all of us, in fact. But the risk of disruption is there. And I think the risk here is that companies focus more on the risk of disruption without looking at the long-term term positive of AI. So in the short-term, I suspect that a lot of stocks will remain under pressure, and I think the next earnings season will tell us a little bit more about it.
