Lessons from Tuchman

Second Quarter 2026 BMO Macro Regime Model – Strategy Report

By Bipan Rai, BMO ETF & Structured Solutions

(Sponsor Blog)

Upon reflecting on the current state of markets, we’re reminded of the lessons from Barbara Tuchman’s The Guns of August, which illustrates how hubris and rigid systems can override rational decision-making.

While we are not drawing direct parallels to the current situation in the Middle East, the book offers important lessons for investors as they navigate portfolio construction in the months ahead.

As an example, periods of higher inflation generally increase the co-movement between U.S. stocks and interest rates, requiring a more pragmatic approach to diversification. This often leads to greater interest in real assets like gold, as we’ve seen in recent years.

But what happens when even gold fails to provide adequate diversification during a geopolitical shock? Tuchman’s work reminds us of the importance of stress-testing assumptions before a crisis unfolds. When correlation structures break down and traditional hedges falter, investors who have considered tail risks in advance are better positioned.

With that in mind, let’s consider the present environment. Even if the Middle East conflict is resolved quickly, the economic and market consequences will likely persist. Inflation risks are no longer symmetrically distributed, and price pressures appear likely to rise. Damage to energy-related infrastructure points to a prolonged period of crude oil and LNG supply disruption, pushing prices higher for longer. This affects refined products (such as gasoline, jet fuel, and kerosene), fertilizer production, and the supply of helium: complicating central bank messaging. Markets have responded by pricing out expected Federal Reserve rate cuts and pricing in aggressive hikes for other developed-market central banks (Chart 1).

Chart 1 – Markets Have Priced in Tighter Central Bank Policy by End-2026

Source: BMO Global Asset Management, as of March 27, 2026.

At the same time, growth risks are shifting in the opposite direction. Higher input costs act as a tax on consumers and weigh on corporate margins. The speed at which rising energy prices feed into slower growth depends largely on a country’s economic slack, which explains why some central banks have recently acknowledged growth risks more explicitly than they did in early 2022.

Indeed, our own proprietary macro regime model is signaling that we are transitioning from a ‘reflation’ backdrop to a more stagflation-like regime (Chart 2).¹ This emerging stagflation regime need not mirror the 1970s, but we are still positioning our portfolios to be more robust and resilient. We’re broadening our commodity exposure to provide a more direct hedge against supply shocks. In an environment where inflation surprises are more likely to be positive, this type of convexity is valuable.²

We are also allocating to front-end TIPS (Treasury Inflation-Protected Securities) as a hedge against inflation pressures. While breakevens³ have moderated with recent disinflation progress, they do not fully reflect a sustained energy shock. TIPS offer a cleaner way to express inflation risk without requiring a strong view on nominal growth.

Within equities, we are tilting toward quality and low volatility. If growth slows while cost pressures persist, companies with strong balance sheets, durable margins, and stable cash flows should outperform more cyclical or highly leveraged peers. Low-volatility exposures can also help reduce drawdowns during headline-driven market swings.

History teaches us that conflict does not guarantee crisis. But periods of stress often reveal underlying fragilities. Our role as stewards of capital is not to forecast every geopolitical development, but to recognize that the distribution of macro outcomes is tilting toward a stagflation-like environment: and to position portfolios accordingly.

Chart 2 – Broad Commodity Exposure is Now a Better Diversification Strategy than Just Relying on Metals

Source: BMO Global Asset Management, Bloomberg. Daily returns from February 27 to March 27.

Asset Allocation

• Relative to the Q1 edition, we’re making some modest changes to our asset allocation splits. The most notable shifts are that we are paring our positions in the equity and alternative sleeves and reallocating them towards fixed income. Of course, these aren’t big changes: as we still remain underweight fixed income and overweight both equities (slightly) and alts.
• Our macro regime model suggests that we are in the midst of a transition from reflation to stagflation: characterized by low growth and high inflation. This is still consistent with the late cycle feel of the macroeconomic backdrop.
• Despite the challenging backdrop, the underlying fundamentals remain sound enough to maintain a neutral/slightly overweight broad equity position for now. Ahead of the conflict, we did see earnings growth across several sectors in the U.S. and Canada. At the same time, the situation in the Middle East remains fluid, which requires us to be nimbler and more flexible.
• In the fixed-income sleeve, the increase in weight reflects our view that the Canadian yield curve⁴ provides better value and that we feel U.S. TIPS should outperform in the months ahead. For the alts sleeve, the reduction in weight reflects our shift away from gold and towards a broader set of diversifiers in the commodity and infrastructure spaces.
• Importantly, we are bullish on the U.S. dollar (USD) for the coming months. This means that our preference is to keep our U.S. exposure unhedged on a tactical basis. The main reasons for this view are the following:
  • We expect the CAD swaps market to price out rate hikes for the Bank of Canada in 2026.
  • We expect USD upside as net long positioning remains relatively light.

Equities

• We are increasing our allocation to ZCN (BMO S&P/TSX Capped Composite Index ETF) as Canada remains well positioned as a commodity and energy producer. With energy prices supported by ongoing geopolitical uncertainty, the Canadian equity market should continue to benefit, though outcomes will remain sensitive to the duration of the conflict in the Middle East.
• For our U.S. position, we are adding ZLU (BMO Low Volatility US Equity ETF) to complement our existing exposure through ZUQ (BMO MSCI USA High Quality Index ETF) . This combination reflects a preference for defensive characteristics and earnings resilience during a period whereby investors remain selective on valuation and fundamentals.

Fixed Income

• We’ve swapped out ZUAG.F (BMO US Aggregate Bond Index ETF – Hedged Units) and added ZUAG (BMO US Aggregate Bond Index ETF) to reintroduce U.S. dollar exposure in the FI sleeve. Our view on the USD is the main reason for this change.
• We’ve also added ZTIP (BMO Short‑Term US TIPS Index ETF) as a tactical position as we expect inflation risks to stay firm given energy and broader commodity pressures.

Alts/Hybrids

• The most notable change we’ve made in Alts/Hybrids is adding a tactical allocation to ZCOM (BMO Broad Commodity ETF) to broaden our inflation and geopolitical hedge. Energy has led performance on a year‑to‑date basis, but a persistent risk premium can support a wider set of commodities, which improves diversification if equity volatility picks up.
• We’ve also upgraded the weight for BGIF (BMO Global Infrastructure Fund ETF) as we continue to constructive on infrastructure, including electric grids, and engineering/construction projects.

Chart 3 – Q2 2026 Regional Exposure

Source: BMO Global Asset Management, as of March 31, 2026.

Chart 4 – Global Equity Sector Breakdown

Source: BMO Global Asset Management, as of March 31, 2026.

Standard Performance Data

Q2 Income Portfolio Strategy Report

Leaning Into the Canadian Curve

• The fixed-income backdrop remains uneven across North America as we see a more supportive setup for Canada as opposed to the U.S.: especially in the front end of the yield curve.
• In our view, the Bank of Canada (BoC) is likely to remain on pause for the next several meetings. That is largely because the impact of the energy price could exacerbate the degree of economic slack in the Canadian economy: offsetting any rise in incomes from the energy sector.
• And as the CAD swaps market has moved to price in rate hikes for the BoC this year, the front-end of the cash curve looks relatively cheap. This creates a tactical opportunity to add exposure in short‑and mid‑term Canadian duration.⁵ To capitalize on that view, we are initiating a long position in ZFS (BMO Short Federal Bond Index ETF) at 10%.
• Further out the curve, we remain mindful that term premium risk⁶ has not disappeared. Long‑end supply dynamics and global spillovers can still reprice duration quickly, which keeps us biased toward parts of the curve where carry is steadier and the policy signal is clearer.
• Another notable change is that we are exiting ZUAG.F (BMO US Aggregate Bond Index ETF – Hedged Units) . With our current view that the USD may hold up better in the months ahead, we prefer not to maintain a structure that would mute potential currency upside.
• We are also upgrading ZBI (BMO Canadian Bank Income Index ETF) to 25% to strengthen the income profile while staying in a familiar domestic credit complex.

Chart 1 – Credit Summary

Source: BMO Global Asset Management, as of March 31, 2026.

Chart 2 – Term Summary

Source: BMO Global Asset Management, as of March 31, 2026.

Standard Performance Data

Source: BMO Global Asset Management, as of March 31, 2026. Past performance is not indicative of future results.

Sources

¹Stagflation is a rare and difficult economic cycle defined by the combination of slow economic growth (stagnation), high unemployment, and high inflation.

²Convexity is a measure of the non-linear relationship between an asset’s price and its underlying risk factors, most commonly seen in bond markets regarding interest rates. While duration provides a linear estimate of how much a bond’s price will change for a small move in interest rates, convexity accounts for the “curvature” of this relationship. 

³Breakevens in bonds, specifically breakeven inflation rates, represent the expected annual inflation rate over the life of a bond, calculated as the yield difference between nominal bonds (e.g., Treasuries) and inflation-indexed bonds (e.g., TIPS) of the same maturity. It is the inflation rate at which both bonds provide the same return. 

⁴The curve on a graph in which the yield of fixed-interest securities is plotted against the length of time they have to run to maturity.

⁵Duration is defined as the average time it takes to receive all the cash flows of a bond, weighted by the present value of each of the cash flows.

⁶Term premium is the extra compensation investors demand for holding long-term bonds instead of rolling over short-term bonds, acting as a reward for taking on risks associated with time. 

Bipan Rai is Head of ETF and Structured Solutions Strategy, Exchange Traded Funds for BMO Global Asset Management. Bipan joined BMO Global Asset Management in 2024 and currently serves as Head of ETF Strategy, delivering strategic research for the ETF and Structured Solutions team. He is highly regarded for his macroeconomic insights as well as his knowledge of market structure for various asset classes. His focus is on fundamental macro research and the implications for the ETF market place, including economic, monetary and fiscal policy analysis alongside developments in funding and liquidity. Prior to joining BMO GAM, Bipan spent 13 years as a top-ranked strategist at a large Canadian dealer. He has won several awards for his research from various publications (Greenwich Survey, Bloomberg) and is a regular contributor to global business media outlets (BNN/​Bloomberg, CNBC, WSJ). He holds an MBA from the Schulich School of Business at York University and a Bachelor of Engineering degree (Aerospace Engineering) from Toronto Metropolitan University.

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