Global share markets are experiencing increased volatility as the conflict in the Middle East escalates. From their record highs earlier this year, Japanese shares have fallen 13%, Eurozone shares are down 11%, and Australian shares have declined by 9%. The ongoing conflict has disrupted energy supplies, triggering a surge in oil and gas prices and subsequently, rising bond yields due to inflation fears. This has led to a sharp decline in shares, fuelled by concerns over higher inflation, interest rates, and weaker economic growth.
The conflict, now in its fourth week, has seen Iran respond by targeting regional oil and gas infrastructure, effectively closing the Strait of Hormuz, a critical chokepoint for global energy supplies. While there are potential workarounds, such as Saudi Arabia’s pipeline and stockpile releases, their effectiveness remains uncertain. The potential for further escalation remains high, with threats of retaliation against energy infrastructure adding to the instability. Average petrol prices in Australian capital cities around $2.45, if sustained, will add 1.5% to inflation, taking it above 5% and add $114 a month to the household petrol bill which along with increasing risks of fuel shortages will lead to a big hit to economic activity.
Despite the uncertainty, investors are urged to adhere to fundamental investment principles. Historically, major geopolitical events have led to sharp market falls followed by a recovery within 12 months. While the current situation presents significant risks, maintaining a disciplined approach and focusing on long-term investment strategies remains crucial. Our base case is that the War and oil shock will be relatively short as Iran will not be able to keep the Strait closed indefinitely and there is a risk of a 15% or so correction in shares this year but the size of the threat means there is a high risk it may be deeper.
