History teaches us that market participants should generally ignore geopolitical influences in portfolios all but for the VERY shortest of time frame traders.
There is rarely a long lasting impact. Some of the most impactful market dislocations were seen decades ago.
Post Second World War, the Cuban Missile Crisis, Korean and Vietnam wars had meaningful impacts, but markets adjusted and there was no material long-term market impact to the fundamental growth of the world. Post Berlin Wall coming down and the peace dividend to the world, Gulf War 1 was also relatively quick.
But 9/11/2001 was an attack on the U.S. and that was longer lasting, but had no longer-term impact, though the tech bubble was still deflating. The exception for 9-11 was that the cost of policing the world increased significantly with terrorism risks globally. In 2023, defense spending made up 13.3 per cent of the federal budget. Since 1980, the percentage of federal spending for the military has fluctuated between a height of 27.9 per cent in 1987 and lows of 11 per cent in 2020 and 2021.
When it comes to the Middle East (outside of Russia and North Korea), they spend the most on military as a percentage of GDP.
We believe this is a huge factor of terrorism and protecting the energy infrastructure. There has been a lot of speculation over the Strait of Hormuz being blocked by Iran, where about 20 per cent of the world’s daily oil needs flow through.
That oil largely goes to Asian markets, not North American, but there is an indirect impact to price as we have seen in the past few days. The longer lasting impact of supply constraints can matter for markets. It took the world about one year for WTI prices to mean revert after the Russian invasion of Ukraine. The period is challenged too for pure analysis given that the world was still somewhat recovering for the supply shock of covid in 2020 and subsequent recovery.
We are featuring this topic because of the heightened war between Israel and Iran in recent days. We noted here after October 7, 2023 that this war was a 9-11 moment for Israel and it would not likely end until Hamas was irradicated from Gaza and likely regime change in Iran.
The only other way for this to end is for the regime in Iran to accept Israel status in the world. Unlike other geopolitical events in the world, this one is likely to be a going concern until this outcome. We do not know if 20 per cent of the world’s oil supply will be cut off.
It’s not in Iran’s best interest as it is their primary source of funding. China and others need the oil like we saw when the West sanctioned Russia and the ROW bought it up rather quickly. This time around, the U.S. dollar is not acting as a safe haven, the US has a massive fiscal challenge and policing the world is getting to be a political challenge.
We would not do much from a portfolio context and do not recommend investors panic, but there is a real risk that this time around, there is more of a lasting impact of higher energy prices should Iran not accept Israel right to exist. The best hedge might be to overweight oil drillers (XOP) that stand to benefit most from elevated energy prices and maybe add a bit of gold.
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