The Iran war: What’s the impact for investors?

Janet Mui
Head of Market Analysis
RBC Brewin Dolphin

While the recent agreement between the U.S. and Iran for a conditional two-week ceasefire and the reopening of the Strait of Hormuz offers a welcome window of de-escalation, the broader economic ripples continue to test market stability.

What began as a relatively calm start to the year – with inflation cooling, economies holding steady, and central banks preparing to cut interest rates – has been upended by renewed geopolitical turmoil.

The impact of the Iran war is already rippling through the global economy: business surveys across major economies point to slowing momentum and rising costs for companies. In a scenario where growth weakens and inflation rises at the same time, markets typically struggle to find their footing.

Over the coming months, three interconnected themes will test investor resolve. First, the risk that the energy prices persist rather than quickly fade. Second, mounting pressure on government finances – particularly in the UK – as borrowing costs climb. And third, a more discerning phase for technology stocks, especially those tied to AI and software.

Let’s walk through each of these themes and what they mean for your portfolio.

Theme one: When will energy prices settle?

The core issue: It’s not the initial price spike that matters most, it’s whether these elevated prices stick around.

Markets are no strangers to geopolitical shocks. Typically, they assume some degree of resolution within a reasonable timeframe.

This situation feels different.

As Helima Croft from RBC Capital Markets highlighted, there’s no single decision-maker. Multiple stakeholders are involved, and the physical realities of energy supply – shipping routes, infrastructure, regional stability – matter more than political statements or diplomatic signals.

Even if we see temporary signs of de-escalation, the risk of renewed disruption remains high. This creates what we call a “structurally tight” market: one where supply concerns don’t quickly disappear, keeping prices elevated for longer.

Why this matters for the economy: Central banks can typically look past short-lived energy price spikes without changing their interest rate plans. But a sustained period of higher energy costs is different – it feeds into broader inflation and can change people’s expectations about future price increases.

We’re already seeing this shift play out. Before the Iran conflict escalated, financial markets expected interest rates to hold steady or even fall this year. Now, markets are pricing in the possibility of rate increases in 2026. Central banks have acknowledged this possibility too, signalling their readiness to act if needed.

Some reassuring context: This is likely not a repeat of Europe’s energy crisis during the Russia-Ukraine war. Europe remains vulnerable as a major energy importer, but its gas supply sources are now more diversified. Gas inventories are lower than ideal and prices have risen, but the magnitude remains well below previous extremes. Crucially, we’re starting from a lower inflation baseline this time. These factors provide some cushion – though they don’t entirely eliminate the risk of a more persistent energy shock.

What this means for your portfolio: Energy stocks remain an important portfolio consideration. Companies in this sector can benefit from a “geopolitical risk premium,” meaning their values tend to rise when oil prices stay high – or face the risk of moving higher – due to geopolitical tensions. Many energy companies also have stronger balance sheets than in the past and pay well-covered dividends, providing potential downside protection.

Theme two: The government finance squeeze

The challenge: The interaction between inflation, interest rates, and government debt is becoming increasingly problematic, especially in the UK.

UK government bond yields (known as “gilt” yields) have risen more sharply than in other developed markets. Think of bond yields as the interest rate the government pays to borrow money. When these yields rise, two things are happening: investors are demanding higher compensation to lend to the government (reflecting inflation concerns), and the government’s borrowing costs are increasing.

This creates a vicious cycle. Higher borrowing costs mean more taxpayer money goes toward debt payments rather than public services or investments. This squeeze on government finances comes at exactly the wrong time – when governments might need fiscal flexibility to respond to higher energy costs or support their economies through weaker growth.

The UK’s particular vulnerability: Even before recent events, UK economic data pointed to limited growth. The private sector showed weakness, and the job market was softening. Now add rising energy prices (which reduce households’ purchasing power) and higher mortgage rates (which are already adjusting upward as market interest rates climb). These forces combine to create a difficult environment: slower growth means lower tax revenues, exactly when the government faces higher debt servicing costs.

What this means for your portfolio: We remain cautious on bonds overall – meaning we hold less than our typical allocation. Our concerns centre on government debt levels and inflation pressures. Within our bond holdings, we favour inflation-linked bonds over conventional government bonds. These provide more direct protection if inflation proves more persistent than expected.

An important nuance: UK gilts have recently underperformed bonds in other developed countries quite notably, which paradoxically makes them look relatively attractive now. Once the current shock subsides, there should be room for UK inflation and hence bond yields, to converge downwards relative to other economies. This could see gilts offering better returns, even if near-term volatility persists.

Theme three: The AI reckoning

The reality check: After a period of indiscriminate enthusiasm, the market is becoming more selective about which AI and software companies could succeed.

The long-term investment case for AI remains. It could transform productivity and business models across the economy. Even the Federal Reserve has raised its longer-term growth forecasts based on expectations of AI-driven productivity gains. However, the market has recently shifted from “AI will help everyone” to “AI will create winners and losers.”

Why the shift matters: Software company valuations have compressed significantly after a sharp selloff, and many now appear relatively cheap compared to their historical averages. But here’s the complexity: while some software companies will successfully leverage AI to enhance their competitive position, others will see AI erode their business models. It’s increasingly difficult to predict which companies will thrive and which will struggle as AI disrupts traditional software markets.

This uncertainty extends to broader questions about AI’s impact. How will competitive dynamics evolve across the economy? What happens to employment during this transition period? How quickly will productivity gains actually materialise? These remain open questions.

Additional concerns: We’re seeing signs of tighter financial conditions affecting certain market segments, particularly private credit funds with heavy exposure to software companies. While these appear to reflect liquidity challenges rather than systemic credit problems, they reinforce a less forgiving market environment overall. Investors can no longer treat “AI and software” as a single, uniformly positive theme.

What this means for your portfolio: We’re taking a more case-by-case approach rather than broad sector bets. This means focusing on individual companies with clear AI exposure, strong execution track records, and reasonable valuations. We’re maintaining exposure to genuine structural growth themes, but with much greater emphasis on differentiation and valuation discipline.

Bringing it together: Portfolio positioning for uncertain times

These three themes – persistent energy shocks, government finance pressures, and AI differentiation – paint a picture of a more complex and less favourable landscape than we faced just months ago.

Some reasons for measured optimism: The global economy hasn’t entered this period from a position of weakness. Corporate fundamentals have remained relatively resilient so far, and starting inflation levels are more contained than in previous crises.

The central challenge: The range of potential economic outcomes has widened significantly, and downside risks have intensified. Investors should prepare for periods of disruption and heightened market volatility.

Your portfolio response: This environment calls for a more balanced and selective approach, with particular focus on inflation protection:

• Energy exposure: Helps hedge against continued supply disruptions and elevated prices.
• Inflation-linked bonds: Offer direct protection if inflation proves stickier than expected.
• Gold holdings: Tend to act as portfolio stabilisers during periods of deteriorating growth and fiscal stress.
• Selective equity exposure: Maintain participation in genuine structural growth themes, but with emphasis on valuation discipline and company-specific fundamentals.
• Elevated cash position: We’re carrying more cash than usual, providing “dry powder” we can deploy when opportunities in other asset classes improve.

The road ahead will likely be bumpy. But by maintaining a diversified, thoughtfully positioned portfolio with built-in protections, we believe we can navigate this uncertainty while remaining positioned to capture opportunities as they emerge.

As always, we’ll continue monitoring these themes closely and adjusting positioning as conditions evolve. If you have questions about how these developments affect your specific situation, please don’t hesitate to reach out to your wealth manager.

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Please note: Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. The information provided should not be mistaken for formal planning advice; it is imperative that you seek relevant advice for your own personal circumstances. The value of investments, and any income from them, can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Information is provided only as an example and is not a recommendation to pursue a particular strategy.