Profits, geopolitics and portfolio positioning | Lombard Odier

The investment landscape reflects geopolitical risks and rising energy prices, offset by strong corporate earnings and a technology-led investment cycle. Beyond the conflict in the Middle East, we present our perspectives and the role of stocks and bonds within portfolios.

Despite geopolitical turbulence and restrictions imposed on energy flows, stock markets continued to advance this year, with emerging stocks in the lead. The sovereign bond markets, for their part, struggled to generate positive performances. Equities have demonstrated resilience, supported by a strong macroeconomic environment, accommodative financial conditions and, above all, strong earnings momentum. Technological and artificial intelligence-related stocks remained the main driver of performance.

As quarterly earnings season draws to a close, new catalysts are emerging. While the conflict in the Middle East will remain a major issue, the broader question is whether the dynamics of interest rates and corporate profits, as well as valuations, can continue to support risky assets. Below we examine five key investment questions and outline our portfolio positioning.

Can earnings continue to drive stocks higher…?

We think so. Despite a solid first quarter, profit expectations for 2026 were subject to further upward revisions, driven by emerging Japanese and American markets. This remains a key support for stocks, especially as valuations in some developed markets become harder to justify – once again exceeding long-term averages. We remain optimistic, however, about the technology sector, where valuations suggest upside potential. Massive investments in artificial intelligence at the data center level and demand records in the semiconductor and cloud/software sectors continue to support earnings.

Equities have demonstrated resilience, supported by a strong macroeconomic environment, accommodative financial conditions and, above all, strong earnings momentum

Emerging markets offer more attractive prospects: stronger earnings growth dynamics than developed markets, more attractive valuations and favorable investor positioning, particularly if the US dollar remains weak. Our overweighting of equities is therefore expressed through emerging values, whose performance seems to be able to extend beyond the markets driven by AI. South Korea stands out for accelerating spending on AI infrastructure and strengthening corporate governance. China and South Africa also offer attractive valuations and profits. Chinese profit growth is expected to recover in 2026 and 2027, supported by exports, investment in AI, moderation of competition and energy resilience, while South African mining companies, which represent around 40% of the index countries, should benefit from structurally high demand for gold. In short, earnings continue to support global equity markets but we maintain a selective approach, as quality and geographic region are decisive.

Do sovereign yields threaten stock market valuations…?

The rise in sovereign yields tends to put pressure on the valuation of stocks. After the recent bond correction, yields have reached multi-year highs in many major economies. The impact of rising rates on stocks, however, depends on the reason why they are rising…: strengthening growth, which generally translates into an increase in real rates, or an increase in inflationary expectations. It also depends on the volatility of yields across the different bond maturities.

The main driver of the recent rise in yields is rising inflation expectations, with markets having already priced in some tightening of central bank monetary policy. In the United States, stock prices imply a rate hike by the Federal Reserve, compared to around three in Europe. The current situation differs from that of 2022, when central banks had to raise their key rates in a hasty manner, against a backdrop of high inflation and real rates in very negative territory, causing strong volatility and penalizing the stock markets. It seems unlikely that central banks will exceed market expectations in terms of monetary tightening. On the contrary, they should be able to lower their rates. Furthermore, although the risks of inflation could increase if the disruptions in the Strait of Hormuz persist, this is not our base scenario. The rise in yields is certainly likely to exert temporary pressure, but we do not anticipate a lasting decline in stock market valuations.

Are bonds still a reliable source of diversification for portfolios…?

The paradigm has changed in recent years. The previous economic cycle was characterized by low inflation, demand shocks and concerns about growth. Sovereign bonds were effective diversification instruments, as growth shocks tended to drive down real rates and support bond prices.

In 2022, the energy supply shock led to an increase in inflation and forced central banks to implement brutal monetary tightening. The resulting fall in sovereign bond prices amplified the losses suffered by portfolios, rather than cushioning them.

No asset is defensive in absolute terms, but only according to the type of shock to which it is subjected. Sovereign bonds generally perform well when the dominant risk is a growth shock – like the global financial crisis. They perform less well in the face of an inflation or supply shock.

No asset is defensive in absolute terms, but only according to the type of shock to which it is subjected

The recent context is different, characterized by greater geopolitical fragmentation, more frequent supply shocks, increased fiscal uncertainty and more volatile inflation. Energy disruptions, conflicts, fragmented supply chains, Covid and tariffs have all created significant supply shocks in a short time frame. These events had a direct impact on monetary and budgetary policies, as well as on financial markets. Therefore, since the Covid pandemic, the correlation between stocks and bonds has intensified.

Recent market movements continue the same logic…: fears linked to inflation and adjustments in terms of expectations of falling rates have pushed yields up. Consequently, sovereign bonds have had a weak diversifying effect this year. Instead, we have maintained our overweighting of gold in the portfolios, as it constitutes a key factor of diversification and protection against equity volatility and geopolitical risks. Despite a consolidation of its price in the short term, the demand from central banks and private investors appears to us to offer structural support to the yellow metal.

How to invest in bonds…?

The current high levels of sovereign yields are attractive for long-term investors (“buy and hold”). In our base scenario, we see little upside risk and expect interest rates to fall over the next 12 months. However, some volatility could persist in the short term, particularly if energy prices remain high. As rates normalize, we also expect the positive correlation between stocks and bonds to continue. Stocks should therefore continue to outperform bonds, especially if profit growth continues. It is only in the unlikely scenario of a resurgence of fears of recession that we could expect a marked decline in correlation, making it possible to revive the diversifying role of bonds in the event of a stock market correction.

We maintain a broadly neutral positioning in bond markets, with an underweight in sovereign bonds and an overweight in emerging market debt denominated in hard currencies. Within government bonds, our preference is for maturities of five to seven years in British Gilts, German Bunds, as well as Swiss and Australian bonds, regions where the risks weighing on growth appear higher than in the United States. This underweight exposure allows portfolios to absorb the risk that a supply shock could cause yields to rise. At the same time, an overweighting of emerging bonds denominated in hard currencies allows them to benefit from attractive income. We maintain a neutral positioning on credit, given the small difference in spreads and yields compared to sovereign bonds of comparable maturity.

What are the main risks to our outlook…?

The evolving situation in the Middle East remains a key factor in market sensitivity. We are closely monitoring the resumption of flows via the Strait of Hormuz as well as energy production. These elements will determine whether the shock will remain geopolitical or whether it will transform into a macroeconomic risk.

For now, earnings remain the primary anchor for stock markets, and portfolios need to take advantage of this resilience

Beyond the conflict, we monitor energy futures, food prices, the yield spread between nominal and inflation-indexed bonds, real interest rates, the trajectory of the US dollar, credit spreads, lending investigations banking and corporate bond issues. Combined, these indicators provide information on inflation, growth, liquidity and corporate financing conditions. For example, if real rates rise, the US dollar strengthens and credit spreads widen, financial conditions will tighten. The markets then integrate a broader macroeconomic and financial shock, and no longer just geopolitical volatility.

Capital expenditure programs also deserve special attention. The technology sector has proven to be a key driver of earnings growth and stock market gains. On the business side, any sign of postponement or reduction of AI-related investments would weigh on profit estimates.

Stay invested

The market environment remains constructive but, given the risks, we remain selective. Earnings growth can support further advances in stock indices, but the potential for multiple expansion is more limited in developed markets. Emerging markets benefit from more favorable valuations and more robust earnings expectations revisions.

The rise in sovereign yields constitutes a risk, but it does not threaten equities in our base scenario, which is based on a gradual resumption of oil flows and on a more favorable initial situation for monetary policy than in 2022.

Bonds retain a useful role in portfolios, but their diversification properties are limited in the face of supply shocks and inflation volatility. This is why we remain selective and maintain our overweighting of emerging bonds denominated in hard currencies in order to diversify sources of income.

The crucial question is whether the conflict will remain contained or evolve into a broader macroeconomic and financial shock. For now, earnings remain the primary anchor for stock markets, and portfolios must take advantage of this resilience.

For a detailed analysis of our core beliefs, please see our publication “ Investment Strategy Monthly, Ten Investment Convictions ”. Our recent document entitled “ Rethink Investments » presents in detail our thematic convictions in terms of actions.