The crisis in Israel
As the appalling human tragedy of the conflict between Israel and Hamas unfolds, the impact on markets will be determined by how far the conflict spreads. It may sound callous to talk in these terms at this time, but we have to remember that we are here to look after clients and that means thinking objectively about these events. It is rare that conflict creates significant moves in investment markets.
If the conflict is ‘limited’ to an Israeli invasion of Gaza and perhaps even Southern Lebanon with no other nations directly involved, then the effect on asset prices is likely to be relatively modest. The real risk comes from what happens if Iran is shown to have played a key role, then it is likely that other countries become drawn into the conflict. There is speculation that Iran (which openly supports Hamas and Hezbollah) may have helped organise these attacks, designed as a means of scuppering the recently improved relations between Israel and Saudi Arabia and indeed other Arab nations in the region. If this is shown to be the case, we may be facing an entirely different magnitude of crisis and if Israel were to strike Iran, perhaps targeting the country’s developing nuclear capability, then the implications would clearly be very significant. Remember too that Iran has grown increasingly close to Russia and China in recent years so the geopolitical reach of the conflict would then be very broad. Under such circumstances, we could expect a significant increase in the oil price, which would inevitably feed through to prices in the wider economy and worsen the inflation situation while also slowing economic growth.
So far, investors are reacting in a predictable but controlled manner and although gold, Treasuries, energy and defence stocks are showing gains, wider equity markets have also risen since the events unfolded. It may be that this muted response is shown to be an act of wishful thinking – investors were after all slow to factor in the implications of the Russian invasion of Ukraine – but at this point we do not see a need to change our already cautiously positioned portfolios. We all hope for a swift and peaceful resolution to this terrible situation.
Global bond yields
The tragic events in the Middle East have contributed to an increased demand for safe haven assets but October began with a significant sell-off in global government bonds. Notably, yields on longer dated instruments rose significantly with the US 30-year bond hitting a 16 year high at 5%. Given that inflation has been moving in the ‘right direction’ and global growth is muted then it might be that markets have taken fright at the high levels of Treasury issuance in the US and the growing budget deficit there. Of course, the higher yields go the more expensive it is for governments to service their debt and so a vicious circle develops. A more straightforward explanation is that investors have finally accepted the Federal Reserve’s (Fed) message that rates are going to be higher for longer, though they have chosen not to believe this to date.
We do think that we face structurally higher rates caused by changes in the global economy but when they impact the system sufficiently for policy makers to change their approach, the returns for investors will be significant. We retain allocations to high quality fixed income in portfolios.
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Investment Line is written and edited by members of the Mattioli Woods Group investment committee and is for information purposes. It is not intended to be an invitation to buy, or act upon the comments made, and all/any investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. The value of investments and the income from them can go down as well as up, and you may not get back the amount invested. Past performance is not a guide to future returns.
All content correct at time of writing.
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