Navigating Volatility: Energy, Defense, and Treasuries in a Tense Landscape

Geopolitical tensions in the Middle East, Federal Reserve policy uncertainty, and landmark Supreme Court rulings have created a volatile backdrop for U.S. equities. Investors seeking to capitalize on this environment should consider rotating into energy and defense stocks while hedging with Treasury bonds. Here's how to position portfolios for this high-stakes climate.

The Middle East Conflict: A Catalyst for Energy Gains

Rising geopolitical risks in the Middle East—marked by U.S.-Iranian military exchanges and threats to the Strait of Hormuz—are reigniting demand for energy stocks. While oil prices have retreated from early June spikes (WTI crude fell below $70/barrel after initial strikes), the region's strategic chokepoint remains a vulnerability. With Iran exporting 1.84 million barrels/day to China through the strait, any disruption could push prices toward $130/barrel, levels last seen in 2008.

For investors, this creates an asymmetric opportunity. Energy stocks, particularly those with exposure to refining and infrastructure, could outperform. The highlights its resilience amid volatility. Companies like Devon Energy (DVN) and Marathon Petroleum (MPC), which benefit from higher oil prices and refining margins, are prime candidates for overweighting.

Federal Reserve Policy: Stuck in Neutral, but Risks Linger

The Fed's decision to hold rates at 4.25%-4.50% reflects its struggle to balance inflationary pressures from tariffs and stagnant growth. While core inflation is projected to reach 3.1% by year-end, the central bank's caution leaves equities in a holding pattern.

The Fed's hesitation to cut rates until 2025 creates a dilemma: equities may struggle to rally in a high-rate environment, but defensive sectors like energy and defense offer insulation. The Supreme Court's recent rulings further tilt the scales in favor of these sectors.

Supreme Court Rulings: A Shield for Corporate America

Two key 2025 rulings are reducing litigation risks for energy and defense firms:

1. Sovereign Immunity for Contractors: In GEO Group v. Detainees, the Court is poised to clarify whether contractors can invoke immunity for actions authorized by the government. A favorable ruling would shield defense firms like Raytheon (RTX) and General Dynamics (GD) from costly lawsuits tied to government-mandated operations.
2. Narrowing Class Actions: The LabCorp case, though dismissed, highlights the Court's reluctance to allow overbroad class certifications. This reduces liability risks for energy and defense companies, which often face class-action suits over environmental or workplace claims.

These outcomes lower legal costs and settlement pressures, freeing capital for growth and dividends.

The Hedging Play: Treasuries for Ballast

While energy and defense stocks offer growth, Treasury bonds provide ballast against Fed policy missteps or geopolitical escalation. The shows their inverse relationship: when equities fall, Treasuries typically rise. A portfolio split 60/40 between energy/defense equities and Treasuries could balance risk and reward.

For example, pairing SPDR S&P Aerospace & Defense ETF (XARX) with iShares 7-10 Year Treasury Bond ETF (IEF) creates a diversified hedge.

Investment Recommendations

• Overweight Energy: Focus on integrated majors (XOM, CVX) and refining plays (MPC, VLO) exposed to oil price upside.
• Rotate to Defense: Prioritize firms with federal contracts (RTX, LMT) and cybersecurity exposure (PANW, CRWD).
• Hedge with Treasuries: Allocate 30-40% to intermediate-term bonds (IEF) to offset volatility.

Risks to Consider

• Geopolitical Escalation: A full closure of the Strait of Hormuz or proxy attacks could trigger a deeper market sell-off.
• Fed Hawkish Turn: If inflation resists, the Fed may delay cuts, pressuring equities.

Conclusion

In a world of geopolitical tension and policy uncertainty, energy and defense stocks are the ultimate “go-anywhere” plays. Pair them with Treasuries to navigate volatility and capitalize on asymmetric upside. The Middle East's instability and Supreme Court's pro-corporate leanings make this a high-reward, calculated bet for 2025.