Geopolitical conflicts have always loomed ominously over financial markets, presenting investors with the formidable task of safeguarding their wealth during uncertain times. In this concise article, we delve into the wealth of historical wisdom and insights gleaned from the ongoing Russia-Ukraine conflict to provide investors with information as they grapple with the ever-evolving turmoil in the Middle East.
The Unpredictable Nature of War
War’s intrinsic unpredictability poses a formidable challenge for investors yearning for a stable, peaceful world conducive to secure investments and future prosperity. Alas, life is rarely this simple or ideal. Whether it’s a world war or a localised conflict, the sudden and unforeseeable nature of these events, coupled with their often-protracted durations, inevitably catches everyone off guard.
The ongoing Russia-Ukraine conflict is an instructive case in point and a current-day lesson. Beyond the heart-wrenching humanitarian crisis it has spawned, this war has set in motion a universal cascade of economic repercussions. These consequences are evident in widespread supply chain disruptions, persistent inflation driven by higher commodity and energy prices, rising interest rates, and a progressively decelerating global economy. And this is just the tip of the iceberg.
The Israeli-Hamas Conflict and The Potential for Another Oil Shock
Short-term impact of various geopolitical events on Brent prices
Just when the world thought it was safe, another unexpected conflict has emerged, this time in the Middle East. In contrast to the Ukraine war, the current Israeli-Hamas conflict possesses a disconcerting potential to spill beyond the borders of Gaza, enveloping other Middle Eastern nations, including Lebanon, Syria, Iraq, and Iran. Of particular concern is the prospect of a conflict with Iran, which, owing to its status as a significant global oil producer, could upend the established order. Further, Iran also has the capacity to rapidly disrupt oil supply from other countries in the region, thanks to its strategic control over crucial oil chokepoints, notably the Strait of Hormuz—a vital conduit for oil and gas shipments from the Middle East to Europe and Asia.
Global Economic & Market Implications
Since the October 7 2023 attacks on Israel, we’ve kept a vigilant eye on the market’s response. As anticipated, oil and energy markets have been at the forefront of our focus. We’ve also closely monitored the U.S. Dollar, bond yields, equity markets, and inflation, all of which have displayed predictably erratic behaviour since the conflict’s inception.
Thus far, we’ve observed immediate and understandable market reactions following the attack. Commodity prices surged, with crude oil witnessing a roughly 5% jump, while gold rose by 1.5%, and 10-year U.S. government bond yields fell by approximately 12 basis points. These varied market responses reflect not only the current geopolitical environment but also the prevailing macroeconomic conditions.
As indicated in the charts above, market performance has shown consistent growth in gold and oil prices as the conflict continues to unfold. This parallels, at least in direction, the response of major financial markets to Russia’s invasion of Ukraine in early 2022 (bottom panel of chart).
However, what distinguishes this situation is the potential for a broader Middle East conflict. Consequently, investors must prepare for further oil market volatility stemming from the interplay between supply constraints in Russia and the Middle East and demand challenges tied to restrictive monetary policies and economic slowdowns in emerging markets and China.
Notwithstanding these challenges, there is a silver lining. History reveals not only the resilience of financial markets during past geopolitical crises but also that the average market decline during such crises has been relatively modest, averaging just 7% before a swift recovery in the ensuing weeks.
That said, investors should not underestimate the looming risk of a substantial global oil shock within the coming 12 months and the associated financial market implications. While major economies have experienced a reduction in their oil consumption intensity over time, making it more challenging for geopolitical oil shocks to disrupt their economies, the potential for emerging supply threats to temporarily elevate oil intensity and volatility, thus affecting global demand and intensifying cost of living pressures, cannot be overlooked.
Given the current geopolitical climate, it is prudent to remain defensively positioned, whilst also remaining alert to further risks or opportunities as they arise. As the situation in the Middle East remains in its early stages, further deterioration is possible before a resolution is achieved. Consequently, we continue to prioritise capital preservation through diversification and careful investment selection, particularly focusing on strategies that offer downside protection. It is also opportune to take advantage of distressed valuations with the expectation that an equity rally is likely to eventuate at some point as markets turn their attention back to economic fundamentals.
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Geopolitical conflicts consistently leave an indelible mark on financial markets, even if their negative impacts are often transitory as our analysis suggests. Recent conflicts may unnerve markets, but historical data reinforces that they rarely result in prolonged market corrections, as witnessed since the Ukraine war’s outbreak in early 2022.
The ongoing Israeli-Hamas conflict once again reminds us of the need to remain vigilant and well-prepared for unforeseen geopolitical events. While markets may experience periods of intense volatility, the wisdom of prioritising capital preservation and remaining alert to evolving risks and opportunities remains paramount.