In a swirling world of heightened uncertainty, investors could be forgiven for hunkering down and minimizing exposure to proliferating risks. Yet paradoxically, the biggest risk may be risk aversion itself.
With the Iran war set to enter its third month, the largest global energy shock in decades is stifling growth, stoking inflation, and confounding policymakers. And that’s on top of the new world order – marked by de-globalization, de-dollarization, and trade wars – that investors were trying to make sense of before the war started on February 28.
All good reasons to reduce exposure to risk assets like equities and adopt a more defensive posture, right? Not really.
As it turns out, money talks. Specifically, profit. U.S. companies – particularly the tech megacaps – continue to generate bumper earnings, largely driven by the artificial intelligence boom. The possible holes in this narrative, like the potentially unsustainable capex binge and the heavy sector concentration, are well-known. But the fear of missing out - “FOMO” - continues to outweigh everything.
Investors are being rewarded for holding the line. Since the war started, traditional safe havens like gold, U.S. Treasuries, and the Swiss franc have all depreciated, while the Nasdaq and S&P 500 have climbed to new highs. The Nasdaq is up 9 per cent since February 28.
Investors who sought cover found underperformance instead.
Other markets around the world have powered ahead too — Japan’s Nikkei 225 and South Korea’s KOSPI both hit new peaks this week — but none carry the “risk on” torch quite like Wall Street.
BlackRock, the world’s biggest money manager with US$14-trillion of assets under management, last week went overweight U.S. equities.
Meanwhile, JPMorgan’s equity strategists upgraded their year-end S&P price forecast to 7,600 points from 7,200, implying a 7-per-cent rise from current levels. This was driven by the upward revision to their earnings per share forecast to US$330 - well above the LSEG consensus of US$315 - based on the AI outlook. If a permanent ceasefire in the Middle East is reached, they reckon the S&P 500 could hit 8000.
In other words, the outlook is either great or really great.
Given this backdrop, there are real costs to standing on the sidelines.
The U.S. economy remains the most dynamic in the world – home to the most innovative and profitable companies as well as the most liquid and efficient markets. The market cap of U.S. stocks is more than 70 per cent of world shares, and U.S. stocks have had a valuation premium over world stocks for the last 24 years.
“No one has been rewarded for selling U.S. equities,” says global capital flows expert Brad Setser at the Council on Foreign Relations. “There’s deep reluctance to be underweight the U.S. and risk underperforming.”
This echoes the “U.S. exceptionalism” narrative that gained currency in 2024. It holds that investors can’t afford not to have large exposure to U.S. equity, especially tech.
While this thesis has been questioned over the past year due to some of President Donald Trump’s more unorthodox and controversial policies, the dominance of U.S. hyperscalers has offset any trepidation about the current administration.
Investors might be wary of the direction of U.S. fiscal or foreign policy, but ‘selling America’ is simply too risky.
There are plenty of reasons why the current Wall Street rally could run out of steam, however.
The S&P 500 just recorded its third consecutive weekly rise of 3 per cent or more. As analysts at Jefferies point out, this has only happened twice in the past 75 years: August 1982, and May 2020.
Additionally, trading volume in “call” options - derivatives contracts that are effectively a bet on further price gains - has reached historically high levels in stocks and exchange-traded funds, especially tech.
This hyper-bullishness means there is little margin for error.
And there are alternatives. Investors wanting exposure to the AI and tech boom have options in Asia, like Taiwan’s TSMC , and South Korea’s Samsung or SK Hynix . There are also several firms in Europe that stand to benefit from the defense and tech spending splurge likely to come in the years ahead.
Investors wouldn’t necessarily be taking a performance hit if they diversify on the margins. While the big three U.S. indices have rebounded strongly from their Iran-war lows in March, Japanese equities as well as the benchmark MSCI Asia ex-Japan and MSCI emerging market indices have performed better year to date.
However, they don’t offer nearly the size or liquidity of Wall Street. And in the U.S., loose financial conditions, strong earnings, and plentiful liquidity all continue to suppress volatility, which, in turn, should attract even more capital.
“When volatility spikes, investors have an incentive to reduce leverage and risk exposure. But when volatility remains contained, risk appetite can stay relatively buoyant even amid broader uncertainty,” says Sophia Drossos at hedge fund Point72 Asset Management.
For now, being cautious is a risk few can afford to take.