Navigating Middle East Crisis And Market Resilience

In the realm of economic and investment analysis, grappling with the aftermath of human tragedies is an unfortunate but essential aspect of the job. From the haunting memories of 9/11 to the far-reaching impacts of Hurricane Katrina, COVID-19, and Russia's invasion of Ukraine, the need to provide commentary persists. Presently, we find ourselves dissecting the recent attacks on Israel by Hamas, contemplating not only the geopolitical repercussions but also the potential effects on global markets.

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View from US National Security Advisors on Foreign Policy

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Last week, at the Yale Club in NYC, I had the privilege of attending a timely conversation with two former US National Security Advisors: Ambassador John Bolton from the Trump administration and General James Jones from the Obama era. Their unified perspective painted a stark picture of the current state of U.S. foreign policy.

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Ambassador Bolton asserted that we have transitioned from the "post-Cold War" era initiated by President George H. W. Bush and are now thrust into a protracted 21st-century struggle against a new axis power, primarily centered around Beijing and Moscow. General Jones concurred, noting that the four decades of appeasement to authoritarian regimes have been perceived as weakness, consequently emboldening adversaries abroad.

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Both advisors expressed a shared conviction that Iran likely played a role in the recent attacks on Israel. Ambassador Bolton highlighted the Biden administration's hesitancy to confront Iran in the context of the Hamas attacks, suggesting a reluctance born out of a potential obligation to take substantive action. They further opined that the Iranian regime is fragile and could crumble swiftly under external pressure.

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In conclusion, both advisors concurred that it is premature to predict the fallout from the Israeli-Hamas conflict definitively, emphasizing the inherent danger in the range of possibilities.

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Perspective on the Market Impact

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While the global economic and market impact of the attacks on Israel remained relatively subdued last week, local financial markets experienced a more pronounced reaction. The TA-125, reflecting the 125 largest stocks on the Tel Aviv exchange, fell 6.5%, and the shekel depreciated 3.3% against the US dollar.

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From a market standpoint, our analysis aligns with the views of General Jones and Ambassador Bolton. A contained confrontation would likely result in minimal global market impact, much like the situation with Russia and Ukraine. However, a regional escalation could have far-reaching consequences.

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For instance, a sustained conflict might worsen an already undersupplied oil market. Stricter enforcement of existing US sanctions on Iran could reduce global oil capacity. Additionally, regional escalation might lead to the destruction of oil infrastructure or the blocking of the Strait of Hormuz, affecting global oil supplies. While OPEC+ members commit to stability, posturing may change.

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The US Strategic Petroleum Reserve (SPR), historically used to counter global supply disruptions, has been drawn down significantly over the past two years, posing potential challenges in mitigating price fluctuations.

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This has added to the extreme volatility in oil prices over the last 3 years.

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Are Oil and Energy Stocks Still a Buy Here?

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The recent dynamics in US oil inventories, dipping to 2022 lows and approaching the lowest point in the past decade, suggest an interesting scenario for oil and energy investments. Over the last ten years, the WTI oil price has not fallen below $80 when Cushing inventories were below the current ~21 million barrels. The negative correlation between inventory levels and oil prices is evident in historical data.

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Owning oil and energy stocks makes sense at these levels, supported by several factors:

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1. Growing Oil Consumption: Even in a subdued growth world, the demand for oil continues to rise.

2. Static Supply: Limited exploration and development in the West contribute to a relatively static oil supply.

3. Resilient US Economy: Despite global economic uncertainties, the US economy remains robust.

4. Potential Middle East Supply Issues: The ongoing conflict in the Middle East could lead to disruptions in oil supply.

5. Challenges for Russian Oil: Russian oil faces difficulties reaching the market.

6. OPEC+ Support: There's a clear inclination from OPEC+ to support prices above $80.

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The US has been drawing on its strategic oil reserve, resulting in reserves being down 50% from 2022 levels. This cannot be sustained indefinitely, and there will likely be a need to replenish reserves to balance supply and demand.

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Whilst most sectors are relatively expensive on PE ratio, the energy space in US s&P 1500 is already starting to price in some value with Forecast NEXT PE ratio materially less than current PE Ratio.

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Summary

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The recent attacks on Israel by Hamas have sparked concerns about geopolitical stability, but the market impact has been relatively contained. Insights from former US National Security Advisors, Ambassador John Bolton and General James Jones, underscore the broader challenges in US foreign policy and the potential involvement of Iran in the attacks.

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From a market perspective, the local impact on Israeli markets has been significant, while global markets have exhibited resilience. However, the potential for a sustained regional conflict poses risks, especially in the oil market. The article explores the correlation between the Middle East crisis and market resilience, shedding light on potential economic repercussions.

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The added section delves into the question of whether oil and energy stocks are still a viable investment. With US oil inventories at historical lows and a complex global supply chain, owning assets in the energy sector appears to make sense in the current portfolio context.

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In conclusion, while uncertainties loom, particularly in the Middle East, the market remains cautiously optimistic, with a keen eye on geopolitical developments and their potential economic ramifications.

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?We should also remember that markets can function at these heightened oil price levels for extended periods, with a full reversal not expected.

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