A narrow waterway in the Persian Gulf has gripped the attention of the entire world following the attack on Iran by Israel and the US. Maritime traffic through the Strait of Hormuz has almost come to a halt as Iran fires missiles and drones on ships trying to pass the waters that carry 20% of global oil exports.
The focus is now on oil and gas prices and what that means for the global inflation outlook and growth, as dangers grow for regional energy assets such as natural gas fields and oil refineries. Risk markets have stayed relatively calm even as crude and gas prices have surged since the conflict began. High yield credit spreads have widened from near historical tights as investors weigh the effect on the broader economy.
Most people draw a parallel to the oil crisis of the 1970s when trying to understand the current situation. The energy shock of the 1970s happened due to a confluence of factors including the Arab blockade of oil flows during the Yom Kippur war between Israel and some of its neighbours, the collapse of the Bretton Woods system and the Iranian revolution. While the sudden rise in oil prices is a cause for concern, prices would need to remain high for a prolonged period to significantly raise long-term inflationary expectations and severely hurt global growth.
Tight spreads
At this point in time, our base case is still that normalcy will return in a matter of weeks, resetting oil prices at lower levels. Much of the Middle East is embroiled in the war as Iran has responded by attacking energy infrastructure in Saudi Arabia, Qatar, Bahrain, Kuwait, Iraq and the UAE. Prolonging the war is in no one’s interest and we believe that the Strait of Hormuz will reopen.
Although the start of the conflict with Iran wasn’t wholly unexpected, the spread of the conflict to the whole of the Middle East has surprised many. Ahead of the event, credit spreads were at the tight end of historical ranges, reflecting investors’ optimism about economic growth, dovish central banks and fiscal stimulus. Indeed, valuation had remained quite expensive throughout 2025 and carried over to the new year.
The Iran situation is a new negative risk, but over the past six to 12 months, our focus was already on the weakening US labour market and waning consumer confidence as we looked for signals to understand the strength of the broader economy. In particular, the unemployment rate has been ticking up. The weakness in private credit and concerns about software companies due to issues stemming from AI were also underlying structural risks to watch. Therefore, we weren’t convinced the narrow difference in yields between the credit market and risk-free rates was entirely justified. It’s important to remember that credit spreads have always mean-reverted – expensive valuation should be a warning sign to investors as it normally highlights market complacency about the future and potential economic risks.
High yield bonds: equity like returns with less volatility
| MSCI World Net Total Return Index, EUR HDG | Global Aggregate Treasuries, EUR Hedged | Global Aggregate Corporate, | ICE BofA Global High Yield Constrained Index, EUR Hedged | MSCI Europe Net Total Return EUR Index |
|---|---|---|---|---|---|
Total return p.a. | 7.1% | 2.6% | 3.4% | 6.1% | 5.7% |
Volatility | 14.0% | 3.3% | 5.1% | 8.9% | 14.5% |
Sharpe ratio | 0.42 | 0.40 | 0.42 | 0.54 | 0.31 |
Understanding company fundamentals is always important, particularly when broader valuations are less compelling. In recent weeks, cyclical high yield credits in sectors negatively exposed to higher energy prices have been weakening quite aggressively, including airlines, consumer discretionary, chemicals and some of the industrials. This is a theme to keep an eye on, as it may present an attractive entry point for patient investors. Those cyclical sectors could also be highlighting weaknesses in the economy about which risk markets may still be too complacent.
Although credit spreads have widened since the conflict began, the price action has still not been particularly dramatic. This reflects an investor consensus that the Iran situation will be resolved relatively soon. We need to stay focused on the tail risk of ongoing conflict and disruption. There could still be a possibility that the warring parties refuse to deescalate or show unwillingness to negotiate. Price action could become more volatile if investors panic and/or changing asset flows pressure credit spreads.
Patience and prudence
This environment calls for a patient and disciplined approach to investing, particularly if the ongoing war takes an unexpected turn for the worse and leaves a lasting effect on the global economy. At present, we believe defensive sectors such as healthcare and consumer staples offer attractive yields over the longer term. Defensives are also theoretically more robust in a slowing economy. As market volatility around the Iran events increases, attractive opportunities should also emerge in more cyclical sectors.
As always, credit analysis is vital. Avoiding companies that are vulnerable to economic downturns due to weak balance sheets, compromised business models or with governance risks is core to successful high yield investment. We believe that volatility in the credit markets is healthy, setting apart good companies from the bad ones, helping to direct capital towards more robust companies, and diluting long term market risk. It’s also important to ensure that the liquidity of a high yield strategy is managed in such a way that the portfolio can be quickly repositioned to adjust to any emerging scenario.
We believe an active, pragmatic and risk-aware approach will stand us in good stead. The high yield credit market has over time proven to be a source of attractive risk adjusted return, with many fundamental strengths such as lower default rates than perceived by many, and lower volatility than equities in down markets. The ongoing turbulence in the geopolitical arena provides attractive opportunities for active managers in the high yield credit space to lock in compelling risk adjusted returns for the long term.
Important information
This document is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. Issued in the UK by Jupiter Asset Management Limited, registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ is authorised and regulated by the Financial Conduct Authority. Issued in the EU by Jupiter Asset Management International S.A. (JAMI), registered address: 5, Rue Heienhaff, Senningerberg L-1736, Luxembourg which is authorised and regulated by the Commission de Surveillance du Secteur Financier.
Past performance is no indication of current or future performance. Performance data does not take into account commissions and costs incurred on the issue and redemption of shares.
No part of this document may be reproduced in any manner without the prior permission of JAM or JAMI.