Following the horror of the Hamas-led attacks in Israel this weekend, global investors are contemplating the potential impact on broad investment markets. Although challenging, during a rapidly developing geopolitical conflict, investors are best suited to stay level-headed, considering that fundamentals ultimately drive long-term investment returns. In general, while geopolitics typically has a short-lived direct market impact, the indirect impacts via inflation, confidence, and economic growth can be more persistent and, ultimately, more damaging.
Investor consideration—Oil prices
The critical macro concern lies with the oil market reaction. Brent crude prices have risen around 5% so far, heading toward the $90 per barrel mark. This increase only partially unwinds the 11% drop in oil prices last week, but there is strong potential for a further rise in prices, although the extent is subject to significant uncertainty. It is worth pointing out that, despite the obvious parallels to the 1973 Yom Kippur War and the ensuing Arab oil embargo, which sent oil prices soaring, one key difference today is that the U.S. is a net oil exporter. As a result, the U.S. economy is significantly less vulnerable to spiking oil prices. In addition, the U.S. holds vast resources of fossil fuels, which should subdue any potential price increase. For investors, a surge in oil prices toward the all-important $150 p/b mark would likely require a significant escalation in tensions, including potential strikes on Iran’s nuclear facilities.
Investor consideration—Global growth
Rising oil prices would pressure the U.S. consumer but, provided oil prices do not spike above the $150 p/b mark, the broad market impact should be contained. Although the U.S. consumer is already facing headwinds from eroding fiscal support and diminishing excess savings, household balance sheet strength is robust and so should be able to withstand additional modest pressure from oil prices.
Investor consideration—Inflation
In today’s economy, with global central banks having tightened monetary policy aggressively over the past 18 months and inflation still above target, the inflation risk is the most pertinent. While central banks will likely look through these developments in the near term, higher energy prices can work their way into core inflation and inflation expectations if sustained. Indeed, in the 1970s, soaring oil prices ultimately drove surging inflationary pressures and a de-anchoring of inflation expectations, prompting aggressive Federal Reserve monetary tightening.
Also read: Middle East Reaction and Outlook
Investor consideration—Bond yields
With the U.S. bond market closed on Monday, it is difficult to parse the reaction. Markets are already nervous about the inflation outlook. If price pressures re-emerge, threatening to undo the disinflation progress made over the past year and prompting additional monetary action from policymakers, that could ultimately threaten a further bond rout. However, at least in the near term, a flight to quality will likely benefit U.S. Treasurys, alongside gold and the U.S. dollar.
Investor consideration—Equity markets
Elevated uncertainty is rarely a supportive backdrop for risk assets. However, as equity markets have been wholly preoccupied with the direction of bond yields, a bond market rally may even stabilize the recent downward trend in equity markets. Today’s conclusion…Risk assets are currently priced for perfection, making them susceptible to any further economic or geopolitical strains and uncertainties. In light of the situation in Israel, it is prudent for investors to maintain a diversified portfolio across different asset classes, with a particular emphasis on defensive sectors. Safe havens like U.S. Treasurys and the U.S. dollar, along with exposure to energy stocks, are preferred for well balanced portfolios today.
