Iran strikes and the ripple effect

The weekend’s events have already moved beyond Iran, with retaliatory strikes by the regime across the region, spreading concern as to the scope of the conflict.

From an economic standpoint, Iran also has the ability to influence the global economy due to its effective control over the Strait of Hormuz. This narrow waterway sees approximately 20% of the world’s oil and 90% of the oil destined for Asian markets pass through.

Hetal Mehta, SJP’s Chief Economist flagged that there could be some pass through to petrol prices and eventually UK inflation should oil prices remain elevated for more than a few days. In a potential worst case illustration where oil prices rise to over $120, inflation could rise from 3% to over 4%. 

“For every 1% increase in inflation, consumer spending would be affected and in turn this could take 0.2% to 0.3% off UK growth”. However, Hetal also points out that an abrupt change in domestic energy prices will come too late to impact the OBR's forecasts to be published on Tuesday 3 March alongside the Chancellor's Spring Statement.

Market predictability so far

Global markets reacted with a degree of predictability on 2 March. Stock markets are lower, while so called “safe haven” assets, such as government bonds, gold and the US dollar have risen. The oil price rose by over 10% early on Monday but drifted back through the day. It remains higher than at the end of last week. OPEC (an organisation enabling the co-operation of leading oil-producing and oil-dependent countries) has agreed to a modest increase in production to help stabilise the market. Economists may be more concerned if the disruption persists as this could drive oil prices higher, feeding into higher inflation and have consequences for global GDP.

Watch and see?

Joe Wiggins, Director of Investment Research, notes that it is much easier to be disciplined when markets are going up. Yet it is precisely in the current environment of stress and uncertainty that investors need to be at their most disciplined. Joe advises investors ask themselves five questions whenever there are market shocks:

1. Do I have confidence in predicting the outcome of the current situation?
2. Can I reliably anticipate the financial market implications?
3. Are any of these potential market impacts likely to be material over my investment horizon?
4. Have my investment objectives changed in any way?
5. Is my portfolio appropriately diversified for a range of possible outcomes?

For long-term investors, the answers to all the above are likely to be an emphatic “no”. It is precisely because of recent events that investors should resist the temptation to change their approach.

Joe also highlighted a study which looked at the coverage of different topics in the New York Times going back 160 years and what implications this had on future stock market returns.¹ This showed that the topic which was the strongest predictor of higher stock market returns over the next 1-36 months was “War”.

Initially this may be completely at odds with what should be expected but the explanation is as simple as it is sensible. The instinctive reaction for some investors and traders in this environment is to sell, unnerved by the near-term uncertainty.

Yet lower prices make valuations more attractive and in turn push up future expected returns, rewarding those investors who stayed the course or took the opportunity to purchase when prices were lower. As Joe says, “that’s by no means a prediction of what will happen, but it reflects that our gut reaction to such events are often wrong”.  

Robin Ellis, SJP’s Director of Portfolio Management, reinforced this messaging reflecting the importance of diversification, discipline and a long-term mindset. Robin highlighted that it’s more often the preparation, ensuing portfolios are diversified before bouts of market volatility that are more important than reactive moves taken during a crisis.  Market events like this are highly uncertain, evolve quickly and cause significant market fluctuations. Whilst tempting, trying to predict how these will unfold so often destroys value over the long term. Looking through the noise, remaining invested and allowing returns to compound over the long term is usually the best strategy in building long term wealth.

Source
¹ War Discourse and Disaster Premia: 160 Years of Evidence from Stock and Bond Markets. NBER