Getting your portfolio strait: Morgan Stanley on asset allocation as Middle East peace draws nearer

It's hard to trust a Trump administration negotiation, but it does seem talks are genuinely progressing on a final peace deal between the US and Iran. 

And with the Strait of Hormuz reopening, we're back where we were a few months ago, when the major worry for markets were a potential AI bubble and stretched equities valuations.

Unsurprisingly, that's where we find ourselves again, with the added stress of an oil supply shock to contend with. 

The more things change, the more they stay the same. 

But markets certainly took last week's memorandum of understanding as a sign to kick things up a gear. As the Morgan Stanley Wealth Management Australia team wrote in a recent insights note:

"When headlines emerged last week that Iran was potentially reopening the Strait, markets responded with a sharp cross-asset risk-on move. Focus has now shifted back to artificial intelligence capex as the dominant structural theme across asset classes."

So if peace in the Middle East is a likely proposition, how should investors be allocating?  

Here's how Morgan Stanley is seeing things for its multi-asset model portfolio. As always, this is for informational purposes only. 

Overweight global stocks, selling Australia

Overall, Morgan Stanley have increased exposure to growth assets, and reduced Australian equities exposure in favour of global equities. 

On the income side, it is pivoting to Australian government bonds and out of global fixed income, and has increased its levels of currency hedging in the face of rising risk-on sentiment. 

"At the asset allocation level, Morgan Stanley prefers global equities and we are underweight core fixed income." 

Short term, it is overweight alternative assets and the Australian dollar, but longer term will be looking to be overweight global equities in developed markets and further underweight Australian equities. 

On equities, it is looking to cyclical names, especially those that can benefit from the AI supercycle and the improved earnings seen in countries like the US. 

"Within equities, our tactical preference is for cyclicals over defensives, supported by improving earnings revisions breadth and light positioning across cyclical groups (particularly semiconductors, metals and mining, banks, capital goods, oil services, and utilities) with the US the most favoured region."

What it's keeping an eye on 

One event that took a backseat to the Middle east conflict was the first Federal Reserve meeting under new chair Kevin Warsh, which centred inflation as the primary concern of the new board.

"The Warsh nomination has been a market-stabilising event amid a ~40% rise in the S&P 500/gold ratio since his nomination. Warsh has clearly signalled inflation, not labour markets or growth, as the Fed's primary mandate."

It's a different story in Australia, where Morgan Stanley says "the backdrop appears more uneven". Softer consumer consumption and sentiment, and weak growth paint a different picture to the rosier outlook in the US. 

But the inflation and rates story may be at an equilibrium for now.

So while the conflict in the Middle East has proven an unwelcome distraction, there's light at the end of the tunnel. The job for investors is being ready for what could happen further down the tracks.