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UK Economic Outlook: The Iran(ish) issue

10 January 2020

So let’s do a short-term round up of markets in a random walk style, drawing out some interesting points:

Equities were down immediately following the assassination. However, as of the 8th of January they’re still up 3% (S&P500) from the same time in December. Arms manufacturers such as BAE and Raytheon are all up c.4% or so since the start of the year (and investing in these may require a certain bold disregard for ESG factors). To this observer, these changes suggest markets don’t really expect significant escalation or spill over right now. 
 
Oil is back upto $70 a barrel, which might seem like a spike, but isn’t hugely different to where it was trading throughout most of 2018 (during the year it recovered from slouching at the $40-$55 mark it had been stuck at for most of 2016 and 2017). As a result, expectation that a sudden increase in oil input costs to firms worldwide causing a slowdown or reduction in corporate margins would seem unlikely right now. An interesting indicator for where the tensions in the regions might go is to look at Saudi Aramco: the dog chasing a car stock (i.e. everyone watches it, but very few own it, at least directly). The giant company if it were located anywhere else in the world would be benefitting from rising oil prices, but instead it’s down nearly 10% since December 2019. What’s amazing about this is that represents $200bn off the company’s value, or c.50% of the GDP of Iran itself.

It would be possible to reel off a number of other markets, gold has surged, government debt yields have moved down a small amount and so on. However, in summary it appears that global markets are not pricing or expecting a significant escalation of tensions, and so an end to the hostilities (or a return to a cold war status) is unlikely to shock markets upwards, and it’s possible that if either the US or Iran make a wrong move there could be significant downside events for risky assets.

Thinking about what might happen next, both short and long-term there are two big observations:
First, in the short-term Donald Trump (seeking re-election) is unlikely to do anything that materially impacts markets or US households. He will likely want to appear strong and perhaps bully Iran a bit, but will be at pains to avoid any form of fuller conflict. In the short-term this should keep market movements fairly muted. The same is almost certainly true regarding trade negotiations with China; a balance is needed between appearing strong and actual pain. This should give investors comfort short-term.
 
Second, the above is how the US wishes to act, but it doesn’t act in a vacuum. Arguably as importantly is to observe that the world is moving away from the USA as the global superpower. Parallels have been drawn between the current situation and the British-Egyptian Suez Canal Crisis where smaller nations felt able to challenge the dominant, but declining power. Whether the US will decline, if it will go gentle into that good night, or rage, rage against the dying of the light, and if China will step into the void, or if we have already seen “peak China” will be interesting to observe. China now surpasses the USA as the dominant trading partner to nearly every country in the world. 

For investors what appears likely is that present global stability will be questioned, regional flare up will occur and short-term risk premia should be elevated. Long-term global growth faces a more significant risk that the global economy becomes fragmented into smaller geo-political trading spheres and technologies diverge all of which fail to interact efficiently with each other. Today it’s hard to predict exactly where the world is heading, but it will be bumpy. Perhaps it is time to consciously invest in the decoupling of the US and China.

The author

Alastair Greenlees

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