President Trump's statements about Greenland strained the relationship between America and its NATO allies. Meanwhile, ass NATO’s prospects came under review, European governments discussed the expansion of France’s nuclear capabilities to encompass allies in the European Union.

In terms of economic data, growth in the US economy during the fourth calendar quarter slowed to 0.7% (at an annualised), rate, far below economists’ expectations for a healthy 2.8%. Without the stimulus from AI-related spending, it’s possible that the US economy may have experienced a recession during the quarter. As a result, its economy expanded 2.2% for 2025, down from 2.8% in 2024. Weakness was also evident in US employment data and the prospects for US consumption, the economy’s main driver of growth, were downgraded.

Concern surrounding the disruptive effect of AI erupted in several industry sectors. These were primarily software-related but also extended to those in finance, logistics and cybersecurity, which all suffered sharp corrections. Those same issues spread to private credit markets, due to their disproportionate exposure to software company loans, prompting a run on illiquid fund vehicles that still remains. There were even concerns that stress in private markets might become a systemic risk for the US economy.

The theme of competition created by AI became prominent during the quarter. The valuations paid by investors in pure-play AI companies in private markets soared, whereas multiples in the public listed tech sector stagnated. The US tech giants again raised their expectations for capital expenditure substantially, and became active issuers in public bond markets for the first time. The sums involved were significant by market standards, but bond markets absorbed the extra supply from these brand-name issuers. Amazon, Alphabet and Meta planned to spend about $635bn on datacentres, chips, and other AI infrastructure in 2026, according to S&P Global, up from $383bn the prior year. By comparison, the total capex of China’s largest internet firms is likely to reach $70bn.

Social media companies were the target of lawsuits and investigations by foreign governments relating to content management (or lack thereof), and several countries took to banning social media usage by children. The rise of AI and the dominance of US and Chinese companies in this new industry have focused the minds of governments globally on their respective “digital sovereignty”.

Risks were emerging even before the Iran conflict, but offsets. Companies in the S&P 500 reported their best quarterly results since the pandemic, growing fourth-quarter earnings by 13% on revenues up 9% versus the previous year. Moreover, growth in profits was more extensive than usual, leading to a view that US market leadership could broaden out beyond the tech sector. However, the 5% depreciation of the US dollar from the fourth quarter of 2024 played a large role in the year-on-year calculation of earnings growth.

Social media companies were the targets of lawsuits and investigations by foreign governments regarding content management (or lack thereof), and several countries banned social media use by children. The rise of AI and the dominance of US and Chinese companies in this new industry have focused the minds of governments globally on their respective “digital sovereignty."

Risks were emerging even before the Iran conflict, but there were offsets. Companies in the S&P 500 reported their best quarterly results since the pandemic, growing fourth-quarter earnings by 13% on revenues up 9% versus the previous year. Moreover, growth in profits was more extensive than usual, leading to a view that US market leadership could broaden beyond the tech sector. However, the 5% depreciation of the US dollar from the fourth quarter of 2024 played a large role in the year-on-year calculation of earnings growth.

Until now, investors have benefited from the boom in AI-related equipment more than from AI models themselves, a strategy commonly known as the “picks and shovels trade” (a better business model is to be the company that supplies mining equipment). As the manufacturer of the high-end semiconductors most suited to complex AI reasoning, Nvidia has been the main beneficiary. The scope of that trade enlarged substantially during the quarter when it became apparent that AI datacentre expansion required an increasing share of global memory chip production. Termed “RAMmageddon”, the shortage of DRAM (dynamic random-access memory) sent memory chip stocks parabolic, along with the share prices of Samsung Electronics, Micron Technology, and SK Hynix. Between the start of the year and the start of the Iran conflict, South Korea’s Kospi equity index rose 48%.

Investors majored on Japanese equities after Japanese Prime Minister Takaichi secured the strongest mandate in the postwar era, enticing investors with hopes of a new round of Abenomics-style stimulus. Between the start of the year and the start of the war, Japan’s Topix equity index rose 16%.

When the conflict in the Middle East began, the attempt to unsettle Iran’s regime was an attempt to replicate the US operation in Venezuela. Events showed that the US government’s geopolitical strategies exacerbated current investment risks.

The escalation of economic headwinds caused market unease, quickly followed by de-escalation reports, which caused stocks to rebound. It’s a pattern that continues, with markets responding to the more optimistic releases and political statements with increased fervour.

The resilience of equity markets is in tandem with the US president’s social media updates on the matter, which have sent markets higher. This is highly unusual, as inflated equity prices are fine for those drawing down assets in retirement, but they act as a drag on returns for those still saving.

The S&P 500 is now back to its all-time-high, despite a 33% rise in gas prices, the dampening of rate-cut expectations and declining expectations for global economic growth. Equity investors should do well to remember that even short-term conflicts can have lasting economic consequences. In the short-term, government spending will increase due to fuel subsidies, and lower growth will lead to higher levels of unemployment and higher welfare payments.

While the link between economic growth and corporate profits is not direct, it is reasonable to assume that many companies will struggle to maintain growth in profits. Measures of inflation are already rapidly increasing, leaving central banks in a quandary similar to the war in Ukraine in 2022. Do they face up to the threat of inflation or prioritise economic growth with a slowdown on the horizon?

Bond markets have been quick to reduce expectations for rate cuts and even price rate rises in some instances, which would normally have triggered significant market declines.

Tariffs, AI-related inflation, an oil-price shock and an arms race all have global, macro-economic implications. Global government bond markets have been quick to absorb the implications, and we believe they trade at close to fair value. Equity markets continue to be the outlier, trading at historically high valuation premiums given an environment of elevated risk.

As shown in Table 1, even at the market’s nadir during the conflict, stock market declines had been minimal, especially when compared with the gains across the last year. Most major stock market indices remained 10-20% above their pre-Liberation Day levels of a year ago. Since then, tariffs on US goods have risen from a couple of percentage points to nearly 15%.

Putting aside capital markets’ short-term behaviour, and whether it is rational or sustainable, the conflict between the US and Iran has exposed opportunities and vulnerabilities that could have lasting consequences for investors. The biggest geopolitical winner is China, having the deepest liquid capital markets. By default, China’s form of government now looks more reasonable compared with the US, its main global competitor across a range of industries.

The conflict has sharpened the contrast between “Petrostates,” championed by the US, and “Electrostates” dominated by China. Renewable energy technologies have emerged as a clear winner, and China’s investments in renewable energy look increasingly far-sighted. The UK chancellor Rachel Reeves urged G7 nations recently to accelerate a shift to clean energy such as solar, wind, and batteries, rather than stay “stuck on the rollercoaster of global oil and gas prices”.

South Korea’s president Lee Jae-myung has made a similar pitch. China can emerge from this crisis with a stronger grip on renewable energy and a world increasingly locked into Chinese supply chains. China also leads in open-source AI models, robotics and, according to some, quantum computing.

China makes up about 3.2% of the FTSE All-World Equity Index, meaning that it is an afterthought in most global equity portfolios, despite having a market capitalisation of about $20 trillion (three times the size of Japan’s equity market). To overcome the bias embedded in global equity indices, investors will increasingly treat China as a separate region in its own right.

The main losers are governments and, significantly, government bond markets. Traders described the market action during the conflict as “carnage”; a not-unreasonable assessment.

The FTSE G7 Government Bond Index (USD) fell by nearly 4% from peak to trough. That index includes the UK’s gilt market, which fell by 5.3%, only a little less than UK equities. The US stock market acted as a better haven than several government bond markets, and the divergence between equities and bonds was noteworthy: bond markets quickly priced in the worst-case scenario while equity markets retained some optimism throughout.

There are reasons for this: shorter-term bonds were hit by rising inflation expectations and higher yield curves. Central bankers confirmed investors’ worst fears by initially reacting more hawkishly than hoped. Governments are already bearing some of the direct costs of the conflict through fuel subsidies. However, long-term bonds were also hit, signifying a further loss of confidence in fiscal prudence and, possibly, also a loss of confidence in central bankers’ ability to manage the inevitable strains in bond markets.

The bottom line is that investors can no longer depend on government bonds to hedge portfolio risk. Many investors will prefer to ride the wave of equity momentum, further exposing them to a correction at a time when equity valuations, macro-economic and geopolitical risks are all elevated