War: Added uncertainty, need for balance

By Kyle Tetting

Renewed uncertainty over cascading global conflict has led to major spikes in measures of implied volatility, oil prices and investor angst. Following swift, numerous and decisive strikes by the U.S. and Israeli militaries, Iran’s Revolutionary Guard launched attacks widely across the Middle East.

Especially concerning is potential disruption in the Strait of Hormuz — a critical choke point for about 20% of the world’s liquid petroleum consumption — and the resulting impact of soaring oil prices, which adds to worries over economic and market repercussions.

As a net energy exporter, the U.S. may be less affected by rising oil and gas prices, though any disruption in those commodities can lead to higher energy prices for U.S. consumers.

Inflationary spikes would be more severe in Europe, which tends to be heavily reliant on energy imports. Along with the ongoing economic impact of the Russia-Ukraine War and Europe’s attempt to boost its broader economic engine, higher energy prices would further burden European economic growth.

Back here in the U.S., the immediate economic and market impacts from the war in Iran is limited near-term. However, a prolonged conflict would place greater pressure on energy prices, leading to a Federal Reserve that would need to renew focus on fighting inflation. While the Fed’s typical interest rate tools aren’t well equipped for this type of inflationary problem, it would be reasonable to expect the Fed to raise rates in response to rising energy prices.

Past surges in energy prices

Unfortunately, commodity price spikes accompanied four of the last six recessions and half of the 10 bear markets since 1960.  If prolonged conflict leads to higher energy prices, we should be vigilant about the potential effects on the economy and markets. And with possibly higher interest rates further slowing the economy, we need to pay close attention to how quickly the war in the Middle East is resolved.

So far, the spike in volatility, while unnerving, has been more bark than bite for investors. Broad measures of U.S. stocks have teetered around flat for the year while balanced investors have benefited from positive returns on bonds and non-U.S. stocks. In that environment, bonds have once again proven their worth.

Questions investors should ask

Should investors continue to shift toward pessimism, it’s reasonable to expect volatility to remain elevated. Importantly, though, volatility simply tells us how investors are reacting today; it doesn’t say anything about what to expect going forward.

Therein lies the foundational questions we investors should be asking ourselves as we face these new uncertainties:

• Have our long-term goals and objectives changed in response to what we’ve learned?
• Has the path forward for the economy and markets fundamentally changed?

Looking ahead

Nothing we’ve learned so far changes my view of the future. I remain cautiously optimistic about the path ahead, both for economic growth and for the stock market. Major developments occur every day and we, as investors in innovative companies, get to participate in that growth.

Looking past the near-term volatility does not mean inaction, however. Now remains the best time to plan ahead for prolonged uncertainty, a conversation we reinforce every day in exhorting balance. The current climate provides a litmus test for our feelings toward our own portfolio.

I expect investor sentiment to shift as quickly as the headlines as this conflict plays out. Any détente would help alleviate concern, while the uncertainties of extended conflict will detract from the reason we invest in the first place.

For this reason, it’s critical that we approach periods such as these with a clear understanding of the roles our investments play. Too much risk leaves us vulnerable to poor decision making if things do get worse. Too little risk means missing out on the best opportunities that still lie ahead.

Kyle Tetting is president of Landaas & Company, LLC.