We find out how an escalation in the Israel-Hamas conflict may impact the global economy and financial markets, and what it means for investors.
The Israel-Hamas conflict has left many investors on edge, driving concerns about how rising geopolitical uncertainty may impact the global economy and financial markets.
The importance of the Middle East in the global energy market is causing unease, particularly as Brent crude oil prices have been inching up even before the escalation of the Israel-Hamas conflict.
Many in the Beansprout community asked if we can share our thoughts about how the rising geopolitical tensions may affect our investments.
Let us look at some of the potential implications of the Israel-Hamas conflict, what they may mean for investors.
Why are investors concerned about the Israel-Hamas conflict?
Before we delve into these scenarios, it's important to put things in perspective. The knee-jerk reaction to conflicts in the Middle East often involves predicting sky-high oil prices, inflation spikes, and stock market declines.
This reaction stems mainly from the 1973 Yom Kippur War, which led to an oil embargo triggering a sudden surge in oil prices, inflation and a global sell-off in equities.
However, this may be more of an exception rather than a rule. Other conflicts involving Israel have not had similar outcomes in recent history.
Factors such as improved Arab-Israeli relations make a repetition of such an embargo less likely. In particular, the Abraham Accords bilateral agreements signed between Israel and the United Arab Emirates and Bahrain in September 2020 normalised relations between Israel and several Arab states.
Moreover, today's energy landscape is more diversified and energy-efficient, reducing the potential impact of an oil embargo.
That said, no two conflicts are the same. So let's find out what are some of the potential scenarios on the Middle East conflict.
What are the potential scenarios on the Israel-Hamas conflict?
Our analysis revolves around two main scenarios:
- a swift resolution to the conflict
- a scenario where the conflict escalates, causing oil prices to surge
Although we paint two potential scenarios, it is in all honesty difficult to see how it will actually play out.
To just give a recent example there were many dire predictions of natural gas prices skyrocketing and its adverse impact on European economies following Russia’s invasion of Ukraine last year.
With the benefit of hindsight none of the dire predictions came true as natural gas prices stabilised and inflation trending down in the last few months.
Scenario #1 - If the Israel-Hamas Conflict Remains Contained
This is the best-case scenario given that neither side in the current conflict significantly affects oil production or supply.
Markets appear to be anticipating this outcome judging from the oil price behaviour thus far.
As of 19 October 2023, Brent crude prices traded at USD90 per barrel and remains below the late Sep peak.
Investors’ fear of greater volatility is also not panning out as measured by the VIX which stood at 20 as of 19 October 2023.
A week after the Russian invasion of Ukraine in Feb 2022 , the VIX went as high as 35.
Scenario #2 - If the Israel-Hamas Conflict Escalates
Fresh inflationary pressures
An escalation of the Middle East conflict into a broader regional war could impact investor confidence and lead to fresh inflationary pressures.
Escalation could occur if Iran becomes directly involved or if critical shipping routes, like the Strait of Hormuz, are disrupted.
The Strait of Hormuz is the world’s single-most important energy corridor with over one-sixth of oil and one-third of liquefied natural gas passing through and without any practical alternatives.
The IMF estimates that a 10% rise in oil prices could increase global inflation by approximately 0.4 percentage points.
Japanese Yen and Chinese Yuan may be adversely impacted with higher oil prices
In the event of decision by Iran to blockade the Strait and oil prices shoot up, the Japanese Yen and Chinese Yuan may be adversely impacted as the Gulf region accounts for more than 90% and 50% of their respective total oil imports.
By contrast, the Middle East accounts for only 13% and 12% for the US and Germany respectively.
Higher oil prices could then lead to a higher oil import bill, although China may be able to cushion some of the impact through higher imports from Russia.
Note that China’s dependence on Middle East oil increased from 39% in 2018 to 54% in 2022. This is in contrast to declining shares for the US and Germany. For this reason, it may not be in China’s interest to see an escalation of the conflict.
How have markets reacted in the past?
The chart below shows that US stock market typically tend to recover in the long term after reacting negatively initially to an escalation in military conflict.
For example, the market saw an initial dip during the six day Arab-Israeli War in 1967, but recovered two months after.
Likewise, the Iraqi invasion of Kuwait in 1990 led to an initial plunge in August 1990, but was back to levels prior to the war by March 1991.
What would Beansprout do?
Flight to safety evident
There is always a flight to safety at the start of any military conflict in the Middle East.
Assets like US government bonds, the US dollar, and gold have seen an uplift with the flight to safety.
Indeed, with US interest rates already higher when compared to other major economies and given its safe haven status, global investors are likely to pour capital into the US.
Energy stocks and defence contractors in focus
Should oil prices be propelled higher, energy stocks and companies involved in oil production and exploration may get a short-term boost. Earlier, we shared how PTT Exploration & Production company may be a beneficiary of higher oil prices.
Companies in the defence industry may also be in focus with rising global defence spending. For example, ST Engineering’s orderbook has reached a record-high and is aiming to tap on international defence markets in the coming years.
On the other hand, a strengthening US dollar may be negative for Asian stock markets in general.
Stocks in the transport and utilities sectors where the main input cost is oil may see a sell-off. In recent days, we have seen Singapore Airline’s share price falling sharply due to concerns on higher oil prices.
Do not time the market
From an investment perspective, the magnitude of military conflicts on markets varies and ultimately depends on the stage of the business cycle.
Therefore, we would not attempt to time investment decisions based on geopolitical events.
Overall, it may be a sound strategy to remain invested in a diversified portfolio through geopolitical conflicts, crises and recessions.
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