The greatest impacts of the horrific events unfolding in the Middle East do not relate to financial markets. First and foremost, we acknowledge the staggering loss of life, security and well-being for thousands of individuals who have been and will continue to be affected by this conflict in the days and months to come. We understand our clients may be wondering how the tragic events from the last week may impact financial markets and their investments. We address some of our thinking in this update.
OIL MARKETS: THIS TIME IT’S (PROBABLY) DIFFERENT
The price of oil, and where it goes from here, has been one topic of discussion. Concerns over supply and energy security are not without precedent. The US oil embargo during the Yom Kippur War in 1973 caused oil prices to quadruple within a very short period of time. This embargo is widely considered to be one of the key precursors to what ultimately became a decade of record-high inflation leading to a severe global recession. Should we fear another energy crisis (and, in turn, a major recession) akin to the one in 1973? We think there are different factors at play today.
One reason we think an oil crisis of 1970’s magnitude is unlikely is that post-pandemic demand for oil has remained sluggish relative to global GDP. While the price of oil has recently rebounded, this has more to do with shrinkage in supply rather than a rebound in demand. Liquid fuel has slowly but surely lost market share to other sources of energy like natural gas and renewables. While global (nominal) GDP eclipsed pre-pandemic levels by early 2021, fuel demand has only just recovered. All that to say, when demand is sluggish, it is hard to create a true energy crisis.
Source: Energy Information Administration (EIA)
Secondly, while the oil embargo did cause immediate economic harm to the US, its long-term effects ultimately provided more hurt than benefit to OPEC. Rapidly rising oil prices directly triggered the very first initiatives to improve fuel efficiency, not to mention exponential growth in global oil exploration. Major oil discoveries in the North Sea, Caspian Sea, Caucasus and even shale fracking were all indirect knock-on effects of the oil embargo, which irreversibly eroded OPEC’s power and market share.
BUT MANY RISKS STILL REMAIN
An oil embargo is but one of countless potential risks and negative outcomes that could occur. Political stability in the Middle East continues to be unpredictable. While we don’t expect an oil embargo, it is not to say that all sources of global oil supply are safe. The potential involvement of other players could well lead to escalating conflict within the region. Depending on the extent of escalation, production curtailments from select countries or military threats to major transportation arteries could still result in higher fuel prices and disrupted global supply chains.
With two major armed conflicts now happening simultaneously, the potential for extremely unpredictable and volatile effects across the globe has increased.
Ultimately, despite our relatively balanced view on energy, armed conflict is most likely a negative for global economic growth. This is particularly relevant given that the world was already contending with higher levels of inflation and the rising cost of debt before the events of the last week.
We have been slowly re-positioning QV strategies for harder economic times over the last 18 months. Today, the overall strategic trajectory of our portfolios remains unchanged. We continue to position the portfolios for heightened periods of volatility and feel comfortable in the resiliency of the businesses in which we are invested.