Just over a year has passed since Hamas’s attack on Israel triggered war in Gaza, sparking the conflicts across the Middle East that threaten to destabilise the entire region. In recent weeks fighting has escalated significantly but, despite the humanitarian toll, financial markets remain largely unaffected with stock markets close to all-time highs and government bonds seemingly pricing in little geopolitical risk premium.
Although the conflict has dominated the newswires, the fact that the Middle East accounts for a small percentage of the global economy, trade and capital markets means that the reaction thus far has been broadly muted. There is some risk premium seen in certain markets relating to the conflict, such as oil and gold, but the broader market reaction has been minimal due to the Middle East being a relatively small player in terms of world GDP, equity and bond markets.
Four Middle Eastern countries are in the MSCI Emerging Market index, with Saudi Arabia (4.4%) followed by the United Arab Emirates (1.3%), Qatar (0.9%) and Kuwait (0.8%)[1]. The Israel stock market capitalisation was US$282.6bn in August 2024, less than 10% of the UK (US$3.24tn) and under 1% of the US (US$40.30tn).[2]
No direct military action
The main market transition mechanism from the conflict can be seen in a 20% rally in the oil price in recent weeks, with international benchmark Brent crude, moving back above the US$80 a barrel level in early October before paring its gains. Iran’s growing involvement is behind the move higher, as Tehran produces around 3m barrels per day (bpd)of oil — far more than the couple hundred thousand barrels Lebanon exports, while Israeli and Syrian production is negligible. Recent history suggests that should Iran become more involved in the conflict, the West would likely retaliate in the form of increased sanctions, rather than direct military action.
Although there has been a strong move higher in the oil price, in a longer-term sense it is not that elevated. Brent crude has declined almost 25% in the 12 months up to 30 September 2024, a period that captures most of the year since Hamas’s 7 October attacks. While we acknowledge the recent move higher, it still pales into comparison compared to the surge in early 2022 when Russian invaded Ukraine and Brent surged past US$130 a barrel.
At the time of writing, oil is trading around the middle of its 2024 range, having been above US$90 a barrel in April and hitting a year-to-date low below US$70 in early September. The demand side of the market has softened in recent months as concerns have grown that central banks have kept rates too high for too long, stifling economic activity and it is perhaps telling that the current price remains below the level on 7 October 2023. Going forward, any disruption to channels such as the Straight of Hormuz — where 20%-30% of global oil is transported (approximately 20m bpd) — would lead to a more sizable impact on the oil price.
Generally speaking, geopolitical events often have short-lived impacts on financial markets, as can be evidenced by the response to the Hamas 7 October attacks. Although there was a notable risk-off sentiment when markets reopened after the weekend, the moves were swiftly unwound and shortly afterwards stocks embarked on a strong move higher. Equity markets have enjoyed a stellar period since then, with the MSCI All Country World index (£) returning over 20% in the 12 months up to 30 September 2024.
Looking ahead we will continue to closely monitor developments in the region, on the lookout for signs of escalation or de-escalation. In our latest asset allocation meeting we maintained a moderate overweight to fixed income, which can act as a positive contributor to portfolios around risk events. Meanwhile, we recently slightly increased our UK equity weighting on a tactical basis, given its 11% exposure to the energy sector and slightly more defensive properties. From a longer-term perspective, we include hedge fund allocations in our portfolio construction in order to add diversification, as these can often provide reduced drawdown risk during times of market stress.
[1] Gulf weightings increase on MSCI Emerging Markets | AGBI