International Equity Strategy Commentary

International equity markets performed well over the first two months of 2026 but gave up virtually all of their gains in March after the US and Israel began air attacks on Iran. Stocks sold off as the oil price climbed above US$100 a barrel, driving inflation fears and higher bond yields. The MSCI EAFE index returned 0.15% in local currency terms and –1.24% in US dollars. Not surprisingly, energy was the best performing sector, gaining 40% as the crude oil price as measured by Brent finished the quarter up 73%. The worst performing sector was consumer discretionary, which lost 15%, with autos weak and luxury goods companies hit by disruption in the important Middle East market and the travel industry. Big net importers of energy had most to lose from the oil shock; Japan had risen 15% by February month-end but fell back to finish the quarter up 1.37% in US dollars.

At the time of writing, a two-week cease-fire has been declared although neither side seems clear about the terms. The willingness of the antagonists to negotiate suggests that both have much to lose if hostilities continue, with the closure of the straits of Hormuz weighing on Republican prospects in November’s midterm elections, and the Iranian theocratic government’s grip on power threatened by the progressive degradation of its infrastructure. Whether the cease-fire holds and what will follow remains to be seen but investors had low expectations and initially welcomed the beginning of a dialogue.

Our baseline view of a deterioration in global economic conditions through 2026 has been reinforced by the Gulf War III shock. This view reflected an assessment that the three key economic cycles – stockbuilding, business investment and housing – had entered time windows for weakness. We were, however, awaiting a negative signal from monetary trends to confirm the forecast. The shock should deliver this confirmation: real money growth will be squeezed by a near-term inflation pick-up, while higher interest rates will likely slow nominal money trends.

In Europe, the second energy price shock in five years along with harsh rhetoric from President Trump, who expected more support from NATO allies for his campaign, is another stark reminder of the need to diversify energy supply and increase spending on defense. This comes at a difficult time fiscally for the likes of Italy, France and the UK but Germany has room to implement its promised increase in spending. Japan’s reliance on energy and raw material imports has pushed the yen lower, adding to the inflationary effect of the rise in crude. Still, economic uncertainty may put the Bank of Japan on pause despite its preference for ‘normalising’ interest rates.

Stock selection was negative across regions, notably in industrials, financials and consumer staples and discretionary. In industrials, Ryanair (-18%) de-rated on higher oil prices, having already weakened on news of a provision for a fine for its distribution practices in Italy, although Q3 numbers beat expectations. In staples Unilever (-13%) announced an agreement with McCormick to combine their foods businesses. Investors reacted negatively to the structure of the deal, which leaves Unilever with exposure to the new combined entity, although the logic of splitting the food operations away from the household products business is sound. In materials Heidelberg (-20%) has been hit by proposed changes to decarbonisation regulation increasing the burden on cement producers but the company should still benefit from better pricing power and Germany’s infrastructure spending. In contrast, mining giant Rio (+19%) was boosted by strong operational results with record iron ore production in the Pilbara region in Australia; Investors also like the growing copper exposure. In real estate, Australian property company Goodman (-14%) disappointed investors by not upgrading numbers, with upward pressure on local interest rates also not helping.

In IT, Japanese services company NEC (-27%) has had a disappointing start on the portfolio after being hit by AI disruption concerns, though should benefit from the broader Japan IT catch-up theme. Semiconductor maker Screen (+20%) fared better as the company is the no. 1 player in wafer cleaning, which is gaining in importance as shrink intensifies. Stock selection was better in healthcare, where not owning Novo Nordisk (-27%) was positive and AstraZeneca (+8%) outperformed the sector after continued strength in its oncology franchise, with management reaffirming steady revenue and profit growth in 2026. Performance was also positive in communications, with Dutch telecom operator KPN (+21%) delivering solid Q4 results and a reassuring 2026 outlook – the company is defensive with a high dividend yield and relatively strong balance sheet.

Activity over the quarter has been elevated and has raised exposure to IT, energy, utilities and real estate at the expense of financials, consumer discretionary, healthcare and industrials. We have introduced electrical equipment provider Siemens Energy, which benefits from an oligopoly in gas services and grid technology and has a strong order backlog and improving mix driving a margin uplift. We have also introduced other defensive stocks such as Sun Hung Kai Properties in Hong Kong and French telecom operator Orange.

In Japan we switched Sony into NEC on concern about a shortage of memory chips for their electronic products. We have also re-introduced Softbank, which remains one of the best AI plays in the market, as well as discount supermarket operator Kobe Bussan – the company has a differentiated private label offering and lots of room to grow in its fragmented domestic market. We have added to emerging markets with the purchase of Taiwan Semiconductor, which continues to benefit from the enormous demand for chips driven by AI. We have also introduced Chinese battery manufacture Contemporary Amperex Technology, which is well positioned in the energy transition theme supplying to EVs and grid storage.

On the sell side we exited several stocks vulnerable to persistent market worries about the impact of AI disruption. These include software companies such as SAP, Amadeus and Xero, business service groups Experian and RELX and online groups Rightmove and Tencent. Investors are reluctant to pay high multiples for companies where the terminal value is uncertain due to the impact of competition from AI. Managements generally see no threat and often cite opportunities, but the market is unwilling to give them the benefit of the doubt.

The AI theme remains a key driver of markets. We are focusing the portfolio on companies that are beneficiaries of the capex cycle while avoiding those making investments with uncertain returns and the potentially disrupted. This is expressed in an overweight in IT and a focus on power generation and related areas such as copper. The energy shock will squeeze real money growth and credit conditions are tightening, so we still favour defensive sectors and quality as economic prospects are likely to deteriorate in the second half. Consumer discretionary is an underweight as stocks are under pressure from lower spending while staples are positioned neutral as food and drink companies are suffering from GLP-1 weight loss drugs impacting sales. We are cautiously optimistic about European fiscal loosening but looking to see this reflected in improving money trends. The focus remains on companies with high margins, economic moats and technological innovation that will deliver return on invested capital above the market average.

The Composite fell by 3.23% (3.38% Net) versus a 1.24% fall for the benchmark.