What does this mean for investors, and why do stock markets continue to seem confident that the worst will not happen and that the damage will be minimal?
The fact that many markets are still hesitant to view the Middle East crisis as a crisis is one of its many peculiarities. Take stocks. Although there has been a decline in markets since February 28, it is still far less than one might anticipate considering the scope of the conflict, the disruption to the world's energy supply, and the total lack of certainty regarding how long this may last.
The MSCI World index of developed markets is down roughly 5.5 percent in sterling terms as of Wednesday's writing. Even worse, the MSCI Emerging Markets has dropped by roughly 10%. While this is not insignificant, it is far less than what most investors would have anticipated in reaction to Iran's closure of the Strait of Hormuz.
However, there is undoubtedly some variance in this. The United States is still doing better than most of the world (down 4%). As one might anticipate, energy has surged; the MSCI World Energy is up roughly 10%. The performance of tech stocks has been relatively stable. Real estate, consumer discretion, and materials are examples of cyclicals that have generally performed poorly.
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Start your trial. However, defenses like healthcare and consumer staples have also been extremely weak, which is unusual during stressful times. This may be partially due to concerns about input costs, many of which are impacted by the price of gas and oil, and the difficulty of passing those costs on when incomes are struggling, but it's not totally clear why.
There isn't much space for safe havens during the Middle East crisis.
In actuality, safe-haven trades in general are not performing as one might anticipate given the Middle East crisis. On average, the US dollar is slightly stronger than other currencies. In stark contrast to its reputation, the price of gold has dropped by roughly 15%. The possibility of higher interest rates, which are generally seen as a headwind for gold, is one common explanation for the metal's decline. Another is that investors, particularly those with leverage, made the decision to reduce their risks by taking some profits following such a robust run-up over the previous year.
Medium-term inflation expectations chart.
Additionally, bonds have declined in reaction to the prospect of rising rates; they have not been a haven. However, the narrative is unclear even in this instance. The yields on medium-term and longer-term bonds have increased, and the 10-year gilt has risen from 4.2 percent to more than 5 percent, suggesting that markets are pricing in higher inflation. However, yields on inflation-linked bonds have moved in tandem with conventional bonds, indicating that inflation expectations have not changed (see above for US bonds; the UK is comparable).
Is this something we can really make sense of? There is some hope that the Middle East crisis won't last too long or that stock prices will decline significantly. The US is doing better than the rest, but markets are still expecting slower global growth. In response to the threat of inflation, they anticipate that central banks will implement tighter monetary policy, but the medium-term effects on inflation should be moderate. Because the past ten years have demonstrated that being defensive doesn't pay off, there is a desire to lower risk (hence profit-taking in gold). It is the best-case scenario, but overall, it is conceivable. If the war continues much longer, doubts must grow.
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