A war has broken out, what should we do with our investments?
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Commodities - Technical Analysis
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As with any war, the situation in Iran that erupted over the weekend could quickly change direction, and it may only take a little to tip the balance toward a better or worse scenario. Moreover, what starts out as a well-crafted military plan can quickly spiral out of control. Economic rationality is overridden by political/military considerations, making it very difficult to make accurate capital market forecasts. This is partly why risk aversion sets in on the capital market in such cases, with individual assets beginning to price in a negative outcome, as we can see in the current situation: stock markets are down 2-5%, oil prices are up 6-10%. As an investor, it is worth following a golden rule even amid otherwise very frightening news: don't rush into anything. Although geopolitical conflicts lead to significant market volatility in the short term, their impact on assets typically disappears almost completely over a longer period (even six months), and any losses incurred in investment portfolios are recouped. The current situation may follow a similar pattern.
There were signs, but it could still be a big hit
There were signs of the Iranian war, as significant US troop deployments had been taking place in the region in recent weeks, which we also considered a potential risk in our latest report. On the one hand, this is due to the significant weight of Iran, and in a broader sense, the entire Middle East region, which is destabilizing due to the war, in the raw materials market. The relatively narrow Strait of Hormuz, through which one-fifth of global oil and LNG traffic passes, lies off the coast of Iran, meaning that any disruption to shipping traffic there will catalyze a rise in commodity prices. This is the primary channel through which the market for risky assets can also become vulnerable, as persistently rising commodity prices undermine economic growth.
From a market perspective, the most important question will be how much oil prices will rise and how long they will remain at high levels (the higher they go and the longer they stay there, the worse the outcome will be for risky assets). The greatest fear, and thus the most negative market impact, is related to the closure of the Strait of Hormuz and/or damage to oil infrastructure in the Middle East. Expectations vary widely, but fear and risk aversion could push oil prices up to $80-100 in such a scenario. Iran has already bombed several neighboring oil-producing countries that have remained neutral towards it, and one of Saudi Aramco's major refineries has been hit by a missile, so it cannot be ruled out that the situation will escalate further in this direction if Iran feels cornered. However, even in this case, oil prices soaring above $100 would be less likely, as countries would probably respond by releasing their strategic oil reserves, which could offset the negative impact of the shortfall for weeks.
However, Iran is unlikely to completely close the strait for a long time (as their military abilities will deteriorate over time) and cut itself off from revenue, especially since China, the largest consumer of local oil, also has an interest in ensuring that shipments to its territory remain uninterrupted. Even in this case, however, a significant geopolitical premium must be factored in for oil prices, with price levels around $80. The reason for this is that shipping traffic through the Strait of Hormuz has already declined significantly (there have been reports of attacks on ships, which discourages the use of the route), insurance companies are not covering the damages, and large shipping companies (e.g., Maersk) are rerouting their ships, which makes shipping slower and more expensive. In other words, even if the strait is not completely closed, the physical oil market is also "tightened."
Will we reach a solution quickly?
It is difficult to estimate how long this situation will last. With Iran now attacking several neighboring Middle Eastern countries, pressure is mounting on the US to end the war as soon as possible. Furthermore, Donald Trump has no interest in a prolonged war situation ahead of the midterm elections. The Persian Gulf countries cannot allow the uncertainty surrounding oil transit and the paralysis of local commercial and tourist centers to continue for long, as this could cause serious future business losses, which, according to some opinions, will lead them to try to exert pressure to end the war quickly. Of course, this does not mean that the situation can be resolved quickly, as the attacks and involvement of neighboring countries could cause the military situation to spiral out of control, to the point where even the US would be unable to contain it in accordance with its original plans. A quick end to the war would require a change in Iranian policy from within, showing a greater willingness to negotiate with the Americans. Otherwise, a change of regime may require ground intervention (air strikes cannot change a regime). This, of course, seems less acceptable to the American side.
Overall, according to the baseline scenario, we see a greater chance of oil prices (WTI) between $70-80 in the next few weeks, with the situation escalating or de-escalating potentially pushing oil prices up or down. To sum up, we expect oil prices to remain in this range (or possibly higher) for a few weeks at most, after which a slow recovery in prices could begin.
And how does all this affect assets, regions, and sectors?
Asset classes: Geopolitical events typically cause short-term corrective waves in asset markets, but they have no long-term impact. This may also be the case now, as the situation primarily affects the larger asset categories through rising commodity prices, but oil and gas prices are expected to normalize after the initial sharp rise, and we see a chance that this could happen within weeks (although the situation is constantly changing, so it is worth treating this with caution). If this happens, growth prospects will not be affected materially, meaning that it may still be worthwhile to hold on to longer-term portfolio items, as they are expected to be able to offset any short-term losses over time. There is no need to rush, but let's see how this new situation may affect our own recommendations.
Stocks: In mid-February, we wrote that several risk factors were intensifying around the stock markets as a whole in the short term, and the current jump in oil prices is another acute risk in the series. For the time being, however, oil prices are hovering around last June's levels, so the stock market correction can be considered mild (especially in the US). The stock market would face a more serious challenge if oil prices were to break through the USD 80 level (WTI), which would also mean a further escalation of the current situation. In the absence of this, we expect only slow correction days (with a 3-4% downside risk in the short term for the US S&P 500 index in the first round), which would fit well with the generally weak seasonal movement until mid-March. It should not be forgotten that, historically, the US stock market recovers its initial losses within three months of geopolitical corrections, while in the case of the 1990 Iraq-Kuwait war in the Middle East, it took slightly longer (after one year, the S&P 500 index was already up 10%). We therefore believe that a neutral position on equities is appropriate in the current situation.
Regions: Due to significant raw material imports (not forgetting the risks associated with LNG imports, which have caused the TTF European gas price to rise by 40% to levels not seen in a year), the European stock market is more vulnerable from a regional perspective, and its recent outperformance relative to the US may begin to narrow, but this fits into the bigger picture, which is that we expect neutral movement between the two regions. Within the emerging markets, India is also a significant oil importer, so the current situation poses greater risks for it and it may underperform in the short term, similar to the Central and Eastern European region, where, however, low valuations may mitigate this. However, this situation is relatively favorable for the Latin American region on our recommendation list, as it is geographically distant from the conflict and Brazil is a significant exporter of raw materials, meaning that rising commodity prices could be beneficial for it in the short term.
Sectors: We see minimal impact from the current situation in the sectors we follow/recommend. There are also more cyclical, higher beta, and more defensive recommendations that can balance each other well in a risk-averse period. The most direct impact is on the energy sector, which was not included in our recommendations at the beginning of the year because, apart from the incorporation of the short-term geopolitical premium, we did not see the right time for a sustained rise in oil prices. We continue to hold this view, and with the readjustment of oil prices, a correction may also occur in the energy sector from current levels, which means that this situation provides an opportunity to manage existing positions. A month ago, we recommended a tactical long exposure to the shares of US shale oil producer EOG Resources within the energy sector, and we are maintaining this for the time being. Following the sudden sharp rise in the share price, we are now preparing an exit strategy close to our target level.
Gold: Geopolitical tensions and risks are significant, which supports the price, but the past year has seen a significant rally, which may be followed by a consolidation and sideways movement after the current short-term rally.
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