Quick Bites | Time for a Cool Head

At the time of writing (noon on Monday 9 March), the All Ordinaries and the ASX 200 are both down more than 4%. The catalyst? A war in the Middle East that seems to be spinning out of control, threatening to spark another energy crisis.

Iran has “closed” the Strait of Hormuz and unexpectedly attacked the Gulf states, with dire potential implications for the global energy market (oil, refining, petrochemicals, LNG, fertilisers) and severe potential consequences for the global economy in terms of fuel availability, inflation and monetary policy.

As we enter the second week since the joint US and Israeli strikes commenced, we highlight some considerations.

• From a market perspective, the biggest variables driving implications remain duration and breadth. The longer the conflict lasts, the greater its impact on the global economy.
• The number of countries and geographic range involved will play an important role in light of global energy markets. As of this morning, Iran had attacked 12 countries including every country surrounding the Strait of Hormuz which, previously, saw 20% of global oil supply and a quarter of LNG pass through its waters.
• Six of the world’s top 10 oil-producing countries are involved in the conflict in some way.
• The longer the conflict lasts in intensity and the more countries involved, the greater the impact on energy prices.

Source: FactSet, Bloomberg

Soaring oil prices have driven up US bond yields. The longer the war lasts, the more it will increase the risk of a stagflationary economic outcome. In this scenario, the Fed would be in a straitjacket, unable to cut rates because of rising inflation, even if the economy weakens.

Source: Yardeni Research

Keep a Cool Head

Whatever the outcome of this war, and of course there are many uncertainties, the probabilities are high that markets will recover in due course. That might take 3 months or 6 months or 12 months. We just don’t know. But we can look at historical precedents for guidance. Morgan Stanley notes that in 22 geopolitical crises since the end of World War 2, markets have on average risen 8% over the following 12 months.

While the conflict will subject portfolios to volatility in the coming days and weeks, at this point we do not anticipate a paradigm shift in the global corporate profit cycle that would drive risk asset classes significantly lower for significantly longer. If we are wrong, it will be because of sustained energy prices that challenge a thus far resilient global consumer or because businesses alter spending and trading plans due to macro policy uncertainty. I learnt a long time ago (during the market Crash of 1987 when I was still a young stockbroker) that it seldom pays trying to jump on or off a fast moving train. Far better to keep a cool head, wait for the train to stop and the dust to settle, and then make informed and calm decisions without noise and stress.