Markets Take the Long View

Financial markets often evaluate and react to geopolitical and social crises quite differently than how we experience these events personally and within our community. The crisis that has erupted since the Hamas attack on October 7th is disrupting life for real people and devastating communities. Our hearts go out to all the innocent victims and families directly impacted. Alongside the humanitarian crisis, there are also economic implications for the region and the global economy. In our role as financial stewards for our clients, we will focus this reflection on those impacts.  

While the events of the past four weeks have shocked the world, altered the course of history, and dominated the headlines, they have not impacted financial markets as directly as one might expect. Prices have remained relatively stable over the past few weeks, and investors are closely watching the headlines from the Fed regarding US interest rate policy as well as further developments in the Middle East. 

Even as geopolitical crises dominate the headlines, investors have remained focused on the same question that has captivated financial markets over the past year: how long will interest rates continue rising? This week, the Fed announced its decision to hold the Fed Funds rate unchanged for the second consecutive meeting after 5.25 percentage points of rate hikes since March 2022. Both stock and bond markets rallied on the news. 

Many investors are now expecting that the Fed is finished raising rates for the foreseeable future, which would be a relative tailwind for asset prices. To be clear, Fed Chair Jay Powell’s remarks left the door open regarding the possibility of additional rate increases if the Fed felt it was necessary. It’s worth noting that investors had similar optimism at various moments over the past 12 months, only to be disappointed when the Fed ultimately needed to push rates higher. It does feel like we’ve reached an inflection point in the cycle; however, only time will tell whether the Fed’s recent rate decisions will sufficiently quell inflation and allow rates to shift into a new phase of stability. 

Amidst the ongoing conflict between Israel and Hamas, most financial markets have been relatively calm. Geopolitical risks have risen, and regional escalation remains a concern. That said, most investors are maintaining a long view and not dramatically adjusting their investment strategy. 

This is not to say that markets ignore war. For example, the value of the Israeli shekel is down sharply since October 7th, reflecting that many parts of the Israeli economy have come to a standstill and domestic growth will be lower than previously expected. Another reaction was seen in the commodities markets, where an immediate 4% spike in oil prices occurred just after the Hamas attack. In the four weeks since, investors have had more time to evaluate the situation, and as a result, oil prices have come back down and are now slightly lower than they were previously. 

As the conflict extends over the coming weeks, the potential impact on energy prices will continue to be a primary risk monitored by global investors. Saudi Arabia and Iran are the world’s second and eighth-largest oil producers, so any spillover into these countries could significantly impact the global oil supply. There is historical precedent – following the outbreak of the 1973 Yom Kippur War, a coordinated oil embargo was used as a weaponized policy, which created an oil shock that rippled through many Western economies. The landscape has shifted since the 1970s, but higher oil prices would still be a drag on GDP growth and corporate earnings. Hence, investors will be paying close attention to any signs that the conflict is expanding. 

With neighboring countries reluctant to get directly involved at this stage, the majority of the economic fallout has been confined to Israel and the Palestinian territories. This echoes the ongoing Russia-Ukraine war, where, despite the tragic impact on human life, the market has focused on the fact that the primary economic declines have been contained to the two countries directly involved.  

The Middle East and North Africa (MENA) region and Israel account for a respective 3.8% and 0.5% of global GDP and an even smaller 0.9% and 0.2% of the MSCI All-Country World Index that tracks publicly traded stocks globally.[1] To add further perspective, the combined GDP of Israel, Egypt, Jordan, Lebanon, and Syria is equal to approximately 4% of the US GDP.[2] The impact will be felt acutely within the region and specific sectors, but the relative sizing should limit the economic contagion felt by the global economy. 

One potentially impacted sector is natural gas markets. In 2022, the Middle East supplied around 18% of the world’s natural gas, of which Iran accounted for 6.3%, Qatar 5%, and Israel 0.5%. There have been some minor disruptions to production already: the Israeli government asked Chevron Corporation to pause operations at its Tamar gas field off the Israeli coast for safety reasons.[3] This field supplied around 1.5% of the world’s LNG in 2022 and, if kept shut, would reduce supply to Europe ahead of winter. The ripple effects from these geopolitical conflicts make the entire system incrementally more vulnerable. 

Despite the uncertain and tragic nature of the current situation, we do not advise making significant changes to long-term portfolio allocations. History shows us that most market drawdowns driven solely by geopolitical events tend to be short-lived. Grounded in this perspective, we remain focused on ensuring that portfolios are fully diversified and that our clients have adequate sources of liquidity to meet any short-term needs. 

Resources
1. ACWI IMI’s Complete Geographic Breakdown MSCI 
2. World Bank national accounts data, and OECD National Accounts data files. World Bank 
3. Israel Orders Shutdown of Key Gas Field as War Rages Bloomberg