To state the obvious, war in Iran has shaken up financial markets this week. Stocks wobbled, bonds tumbled, the dollar snapped its losing streak, oil prices sprang higher and natural gas went whoosh. But investors are not bracing for disaster. Instead, it is more a case of them doing a bit of spring cleaning to their portfolios. This may well prove to be too sanguine.
We all know that the human cost of this war eclipses its financial-market impact. But we also all know that the Middle East’s almost unique capacity to trip up the global economy, and our joint prosperity, through the channel of oil and gas, makes this outbreak of violence through the region a matter of deep importance to the financial system. The potential for a serious economic and financial accident here is real.
And yet, every conversation I have had with analysts and investors in the past few days, and the tone of almost every research note, has been something like this: “Don’t worry. Yes, this could get bad. Very bad. But Donald Trump doesn’t want high petrol prices in the run-up to the midterm elections in November, so his military will not stick around. The conflict won’t last long, oil and gas supplies will quickly get back to normal. History says the wisest path is to keep a cool head and stay invested, especially as the US, home to the world’s dominant financial markets, is nicely insulated from any energy supply shock.”
History is the best that fund managers have to go on here, and it is unambiguous. Geopolitical shocks very rarely leave a lasting dent on asset prices, and market recoveries are just too good for any investors focused on the best interests of their clients to miss out on.
“The median response of the S&P 500 [US stocks benchmark index] following a geopolitical shock is, perhaps surprisingly, positive,” pointed out hedge fund group Man in a note. “Indeed, one month after ‘event ground zero’, the median price return is plus 2 per cent, nearly double the unconditional monthly move of plus 1.1 per cent. It is in positive territory 62 per cent of the time.”
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As Man also stresses, the median may not be the best guide. Conflicts are not created equal. But this helps to explain why stocks, bonds and currencies have not gone into crisis mode. Trump’s assault on the global trade system last year sent every asset class on earth reeling. By comparison, his assault on Iran, alongside Israel, is small beer.
The oil price is nearly 50 per cent higher now than it was at the start of this year. That hurts. But Brent — the benchmark oil price — is still possible to stomach at current levels of about $90 dollars a barrel. It’s not at $100 and staying there, an outcome that most economists agree would be a different matter.
The price of natural gas has risen by more than 60 per cent, and again, ouch, especially for Europe. But we are not in 2022 territory, when Russia’s full-scale invasion of Ukraine smashed the continent’s energy networks and made a long-Covid inflation problem worse.
The MSCI Global index shows that stocks have dropped, but by around 2 per cent. For context, a few days of the “Liberation Day” tariffs lopped 10 per cent off the same benchmark. Today’s episode does not paint a similar picture of traders and investors in brace position with their heads in their hands.
Instead, they have been taking profits on some bets that have performed nicely in the past few months. “For sure, the market is pricing the inflation impact,” said Vincent Mortier, chief investment officer at asset manager Amundi, in a presentation this week. Bonds are deeply allergic to higher inflation, and they have weakened in response to the conflict, tripping up the many investors who had been betting the other way. But the bond market is not panicking.
“What’s dropped the most has been what’s performed the most in the past months,” Mortier said, pointing to stocks in Japan, Korea and even Europe, and to emerging-market currencies. That shows that investors have wanted to lock in some gains from previous months without interfering in core bits of their portfolios.
This all clashes rather strongly with the distress evident in the energy sector, including the blunt warning from Qatar’s energy minister that war in the Middle East could “bring down the economies of the world”. This is not hyperbole. We really could be on the brink of a huge energy shock, which would be felt most keenly by Europe, emerging markets and Asia, not by the US, whose officials appear to be taking bombastic glee in the destruction.
It is not clear at this point that Trump can stop what he, with Israel, has started. Oil and gas supplies from the Middle East are in danger, whatever the US president’s desired level of gasoline prices between now and the November elections. What is clear is that markets are unprepared for a long conflict, and the risk of bonds and stocks weakening in tandem, leaving investors with nowhere to hide, is serious.
Be under no illusion from this week’s wobble in asset prices — what we have seen so far is mostly a spot of housekeeping by fund managers. They are not ready for a shock.
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