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A couple of weeks ago I wrote that:
- All that matters for markets is getting the Strait of Hormuz open.
- It was pretty clear the US would want to de-escalate in a few weeks.
- It wasn’t clear at all how the Iranians would react.
And that is, I think, still the right framework. The US announced a pause on attacks on energy infrastructure on Monday, and it looks like negotiations have begun (with the US extending the deadline by 10 days overnight). You are looking at either at some sort of deal where the Strait of Hormuz opens (I am not sure the rest of the deal really matters from a market perspective) or escalation with real damage to plenty of energy infrastructure. For what it’s worth, I think a deal is the most likely outcome. But lets say it is a 60% chance, then that is still a 40% chance of a really nasty energy shock (well above the one already happening) coming our way. Those are not great odds.
In terms of market impact/opportunities, the problem remains that it is unknowable how the Iranians will choose to play this. And returns for most markets are correlate to that outcome. As an example, here are the returns of various markets for March MTD and for the first three days of this week (after Trump announced the energy ceasefire and that talks were under way):
You can see that where oil goes, equities, bonds and gold go in the opposite direction. Gold is, of course, the surprising one. Part of the story during its recent meteoric rise was that it was a hedge against geopolitical tensions. This has emphatically not been the case. I think that any asset that is up +27% in a year then up +64% the year after will inevitably attract plenty of tourists and hot money. The war looks to have flushed out some of this new money, and taking profits on gold would have been tempting given what was happening elsewhere. I would expect that, when we are resolved one way or the other here, central bank buying of gold will continue and the gold uptrend will resume. But, for now, gold is a risk asset like any other and remains in the hands of the Iranians.
If a deal is announced, then I think the right strategy is (as we saw early this week) to do nothing. Your end of February portfolio is probably the right one. But what if it isn’t? Here the I think the analogy to 1990 is helpful. Iraq’s surprise invasion of Kuwait saw oil double in price, US equities fall by -14% followed by a global economic slowdown. The important thing to me is that Alan Greenspan cut rates in this environment from 8.0% to 3.25%. The UK is currently pricing in three rate rises in response to this shock. This just looks wrong to me. And Alan Taylor, who is on the Bank of England’s Monetary Policy Committee, looks like he agrees. Yesterday, he gave a speech where he said this was more like 2011 (when oil jumped up to $125 a barrel in just a few months and the Bank of England did not react) than 2022:
If there is no deal and we have some sort of ground war to open the Strait, then I think the front end of bond markets (which should benefit most from rate cuts) are a buy.
And what of equities? Equities tend to go where the economy goes, and escalation will be bad for both. But that said it is worth noting that the global economy is much less dependent on oil than it used to be:
This should help create more relative winners and losers from the shock. One obvious point here is that the US is now a net exporter of energy and the home of the ongoing AI revolution. This should make it a winner in relative terms vs. energy importers like Europe and many emerging markets. A trillion dollar plus SpaceX IPO is rumoured to be on its way. Whatever you might think of solar powered data centres in space, they don’t have much to do with the Strait of Hormuz.
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.
