When the world was already grappling with high interest rates and inflation, the Israel and Hamas war has added fuel to the fire.
In India, the benchmark Nifty fell around 2.5 percent in these 3 weeks, but this was mostly due to the sharp rise in yields. Meanwhile, more pronounced moves since the attack in geopolitically sensitive asset classes like oil (Brent crude up 11 percent) and gold (up 9 percent) have brought questions around side effects for the economy.
Christopher Wood, global head of equity strategy at Jefferies in his latest weekly note to investors, GREED & fear said that he believes that Markets will continue to try to ignore events in West Asia so long as no invasion is launched. This can even trigger a relief trade in the markets, allowing them to ignore the native implications of uncomfortably high bond yields for a while, he noted.
Wood predicts that Israel is not going to launch a full-scale ground offensive, that view has been increasingly reflected in markets as evidenced by the correction in the oil price last week even despite today’s news of an in-and-out “raid” by Israeli defence forces into northern Gaza.
“If GREED & fear is wrong and the invasion is launched, there will be an immediate negative impact in terms of a spike in the oil price and renewed concerns of a broader regional conflict, concerns which unfortunately will be quite legitimate.
Another alternative view is that Israel is biding its time, waiting for the news cycle to play out, while working out the best plan of attack. This is, certainly, entirely possible, he added.
While Greed & Fear believes markets will continue to ignore the event in the Middle-East, and the decline in equity markets supports the same, another brokerage UBS, also noted that geopolitical events have rarely caused a global recession or left a lasting mark on markets.
Hence, UBS believes that the best course of action is almost always to stay diversified and stay invested.
"In this case, the Israel-Hamas war comes at a time of already elevated geopolitical tensions, with the ongoing war in Ukraine, and the intense rivalry between the US and China. At the same time, even though the US economy has remained very resilient, we expect growth to slow in the fourth quarter, inflation to continue to cool, and yields to trend lower over the next 12 months. Against this backdrop, we continue to prefer fixed income to equities, and recommend investors consider buying high-quality bonds, which now boast great potential for price appreciation alongside compounding," UBS advised.
Within equities, the brokerage said that it was already positive on the energy sector prior to the attack by Hamas as the supply-and-demand backdrop was supportive of current oil prices. The war further supports our view on energy, which can serve as a relative hedge within sector allocations against the risk of a further escalation and rise in oil prices, it advised.
UBS also predicts how oil and gold can be impacted by this war. Let's find out:
When it comes to the market reaction from here, oil remains the main transmission mechanism, and a significant move higher is the key risk to watch, said the brokerage. While there is no set oil price that will tip the economy into a recession, the relationship with the US consumer is very much linear: Every dollar that gasoline prices rise as a result causes a bit more pain, incrementally redirecting spending from elsewhere, it explained. This, of course, has trickle-down effect to earnings and complicates the Federal Reserve’s battle against inflation, noted the brokerage.
"As we know from history, geopolitical risk premiums can disappear quickly. And whether the initial moves intensify will depend on how relationships in the Middle East evolve among Israel, Hamas, other local and regional players, and most importantly, Iran. As of now, we don’t expect oil prices to spiral out of control. We believe the most likely scenario is that Brent crude oil fluctuates between $90/bbl and $100/bbl, alongside any local escalations such as involvement from Hezbollah. While pressure toward the$105–110/bbl range is possible with an incremental reduction in Iranian exports, there is currently spare capacity sitting with OPEC+ to help offset the impact. A more pronounced move above $120/bbl likely would only come with a significant supply disruption. There are a few ways this could feasibly play out: through a larger removal of Iranian oil from the market; a closure of the Strait of Hormuz, which accounts for over 20 percent of the world’s daily flow," UBS predicted.
But while none of these outcomes can be ruled out, they are currently tail risks. Initial reactions from the US have skewed toward de-escalation, and with Israel immediately focused on its imminent ground operation in Gaza, the desire to confront Iran is likely low, at least in the near term. And even if oil prices did move to extreme levels temporarily, UBS doesnt not expect them to be sustained.
The bottom line: Its base case is that oil prices remain relatively contained, and as long as supply disruptions don’t feed through to the consumer for a prolonged period, the Israel-Hamas war is unlikely to be a main driver of the macro picture for now.
Outside of uncertainty around oil prices, perhaps the most common investment-related question accompanying any war or crisis is, 'Should I buy gold?'.
If you look at history, while no two risk-off events are identical, the percent change in the gold price has been around the mid-single digits, on average, UBS pointed out.
"Once again, we’ve seen gold prove its worth as a geopolitical hedge in the days and weeks following Hamas’s attack. This supports our view that gold’s importance in long-term portfolios has only increased in recent years alongside geopolitical unrest, and we believe investors should hold onto existing positions despite the latest rally. Still, we would remain cautious in chasing the recent move too aggressively. To be a buyer of gold here, you must believe this conflict is going to meaningfully escalate—which is not yet our base case. And in the absence of a major escalation, you’re left with a relatively uncertain fundamental picture," it advised.
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