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There is a danger in this job that you think you can suddenly become an expert in the Middle East or US election dynamics or any of the myriad events that move markets daily. With that warning (to myself) out of the way, I want to write this week about the Israel/Iran war. My aim here is not to prognosticate on what is happening now or might happen next (this Columbia University Energy Exchange podcast has far more qualified people talking about just that if you are interested). Instead, I want to talk about the impact it has had on our portfolios and the potential opportunities it might throw up. My first message would be the equity market reaction so far has been pretty muted. Global equity markets are essentially flat (in sterling terms at least) since Israel launched its first attack a week ago. Oil has unsurprisingly spiked but its longer term downtrend still looks intact and Brent Crude is (again in sterling terms) still below where it started the year:
That’s not to say things can’t get worse. Escalation here might mean the US entering the war and Iran doing its best to shut down the 20m barrels of oil that flow through the Strait of Hormuz. In that case, I’d expect to be back above $100 a barrel pretty quickly and equity markets to fall. But even then, I am not sure that would cause us to move our equity positioning too much. I first showed this chart in my weekly note just after Trump’s tariff shock in April. Markets have subsequently recovered all their losses since then. The usual playbook for geo-political is recovery after a short, sharp shock. I have no reason to think it would be different this time.
Still, higher oil is a tax on consumers and a drag on the global economy. One place where this might prove to be an issue is the UK. An increase in the Ofgem energy price cap and continued strong wage increases have been keeping UK inflation above its 2% target. Recently though, cheaper oil has been one tailwind that has helped offset some of these rises. But it looks like this tailwind has gone away for a while. And as inflation drifts higher, UK employment levels are starting to fall sharply.
This cocktail of rising inflation and falling employment is not a very friendly one for the Bank of England. In 2022 it signalled it would let unemployment rise to make sure inflation fell. But today, the Bank looks to be more focussed on the weakening economy. The Monetary Policy Committee voted 6-3 this week to keep interest rates at 4.25% but I’d note the three dissenters all voted for a cut. The Committee are (rightly in my view) more focussed on the weakening employment picture I show above than today’s above target inflation levels. Reflecting this approach, the market now expects 3 cuts in the bank base rate to take it to 3.5% over the next 12 months:
Regular readers will know I have shown these market forecasts before and they have typically been too optimistic (so the promised cuts have not in fact materialised). But remember, these forecasts have, since 2022 at least, consistently been made assuming a weakening economy and a potential UK recession. The fact that this hasn’t (yet) materialised is, I think, mainly because of good news: the economy has so far remained relatively resilient and unemployment low. But the risk continues to look to me that the UK economy finally keels over under the weight of tax rises, high interest rates and tariffs. If it does, I think gilts are a buy here. If it doesn’t, well, that table with the market’s expectation of interest rate cuts will probably prove to be wrong once again. But – and again as we have seen for last few years – the more resilient economy this implies is normally a pretty friendly environment for equity markets.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
