What rising geopolitical tensions could mean for the markets and economy
Chief Investment Officer Chris Hyzy asks several experts about today’s volatile global situation and the steps investors might consider taking now
“Geopolitics used to be considered a lower-level financial risk. Now, it may be the top risk.”— Chief Investment Officer for Merrill and Bank of America Private Bank
WITH ALL EYES ON THE TRAGIC SITUATION IN THE MIDDLE EAST, the first concern is for the victims of the terror attack in Israel and the ensuing humanitarian crisis. The war comes even as we remain concerned about continuing conflict in Ukraine and tension in the Indo-Pacific that have created a new level of uncertainty over the potential impact of global turmoil on the economy and financial markets. “Geopolitics used to be considered a lower-level financial risk. Now, it may be the top risk,” says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.
Moreover, the geopolitical tensions come at a time of uncertainty over the direction of the U.S. economy. “We are on fragile ground globally and in rare territory in terms of the business cycle at home,” Hyzy says. “In a volatile world, understanding the risks and keeping a wide lens on the opportunities that develop are arguably more important than ever.”
Below, Hyzy asks several top analysts from BofA Global Research and the Chief Investment Office to weigh in on the potential impact of today’s heightened global tensions and what it could mean for your portfolio.
“We have found that geopolitical shocks such as 9/11, Brexit and even the prolonged Russia-Ukraine war have not had a meaningful impact on U.S. corporate earnings.”— head of U.S. Equity & Quantitative Strategy and head of Global ESG Research, BofA Global Research
Q: Savita, what sectors are likely to be most affected by the current conditions, and how are markets generally likely to respond?
A: Oil price spikes from potential supply shocks could hit U.S. consumption, but contrary to popular belief, that’s more likely to affect consumer staples — supermarkets, discount retailers and personal products — than higher price-point retailers in consumer discretionary. That’s one reason for our underweight position in consumer staples vs. our overweight in consumer discretionary. Energy companies could benefit from higher oil prices, and U.S. energy independence could otherwise soften the impact of global supply shocks. More generally, history tells us that geopolitical shocks that don’t fundamentally impact the economy have tended to result in a 5% to 10% pullback in the S&P 500. Fortunately, our research shows markets have typically more than recovered from such losses within three months1.
Q: How are corporate profits likely to be affected?
A: We have found that geopolitical shocks, such as 9/11, Brexit and even the prolonged Russia-Ukraine war, have not had a meaningful impact on U.S. corporate earnings. But the Israel and Gaza crisis could affect profits in some sectors. Amplified U.S. defense spending could benefit aerospace, defense and some industrials. But a longer, broader conflict could create greater uncertainty around global trade, demand for overseas travel and the risk of an oil embargo. Earnings for U.S. multinational companies may be affected if oil shocks and uncertainty cause growth to slow in Europe.
“The risk of a Persian Gulf shutdown could push oil prices above $130 a barrel. If shipments through the Strait of Hormuz were stopped for a meaningful period, oil could spike to above $250 a barrel.”— head of Global Commodities, Cross-Asset Quantitative Strategies and Equity Derivatives Research, BofA Global Research
Q. Let’s take a deeper look at the global oil markets, Francisco. What might the conflict in the Middle East mean for global oil prices?
A: Israeli-Palestinian conflicts since 1973 have had a limited impact on energy prices because they have mostly been contained. The key question is whether this conflict will broaden regionally. If it does, the risk of a Persian Gulf shutdown could push oil prices above $130 a barrel. If shipments through the Strait of Hormuz, a choke point for nearly 20% of the world's oil and liquified natural gas (LNG), were stopped for a meaningful period, oil could spike to above $250 a barrel and LNG might surpass $50 per million Btu (MMBTU). Even if the conflict doesn’t broaden, the U.S. could decide to enforce Iranian oil sanctions, curbing global oil supply in 2024 and likely pushing oil and LNG prices higher.
Q: What’s the outlook for other commodities?
A: In the short run, the big beneficiary of rising geopolitical risk is gold, which has moved up very fast in recent days to reflect the increased Middle East tensions. In contrast, base metals may face further headwinds in the short term, although we believe that the downside for most commodities will ultimately be limited. Longer term, as the world economy moves from fossil fuel to renewable energy, we remain constructive on energy-transition commodities.
“At present, the global economic impact has been low and the broader financial markets have not yet priced in the potential tail risks of further escalation.”— head of CIO Market Strategy, Chief Investment Office, Merrill and Bank of America Private
Q: Joe, what risks are you watching for, especially if the very fluid Middle East conflict becomes protracted?
A: Throughout the year economic and market conditions have had quite a few headwinds blowing every other month while rates have headed consistently higher. Now, geopolitical risk has taken another significant turn higher with the tragic events in the Middle East. While we can’t foresee how events may unfold from here, at present, the global economic impact has been low and the broader financial markets have not yet priced in the potential tail risks of further escalation. We can only hope that the current conflict remains as contained as possible. If the situation does escalate, the potential risks include an oil price shock, an even stronger U.S. Dollar, higher gold prices, much slower than expected global economic growth, elevated pressure on emerging markets, further weakness in small-cap stocks and less profitable high-growth shares.
Q: Does the current situation change how investors should view international equities, including developed and emerging markets?
A: The conflict reinforces our tactical strategy for caution on international markets. Although international developed and emerging markets continue to trade at a discount to U.S. equities and offer relatively attractive dividend yields, the risks in those markets in the near term favor more U.S.-centric portfolio positioning and higher-quality assets overall. Significantly elevated geopolitical risk outweighs the sizable discounted valuation of emerging markets, in particular, at this point — at least until we are firmly in the part of the cycle where the Federal Reserve has cut rates and a new expansion is within sight. We’re also watching Europe and China, where a resulting spike in oil prices could have significant consequences for their economies.
Given today’s rising geopolitical tension, the CIO continues to emphasize a high degree of portfolio diversification, which could include alternative investments for qualified investors, exposure to energy, mining and minerals, as well as defense and cyber security. This may include investments in entire sectors or individual securities, where appropriate.
“Diversification across asset classes, industries and geographies can help dampen volatility during times of acute market stress.”— head of Portfolio Strategy, Chief Investment Office, Merrill and Bank of America Private Bank
Q: Marci, how should investors be thinking about their portfolios at this time?
A: Acute geopolitical events create uncertainty for markets and can drive spikes in market volatility. For investors, it’s critical for clients to consider the big picture and what impact, if any, the current environment will have on longer-term economic growth, energy production, government spending and other variables. Our view is that, ultimately, it’s the fundamentals of economic growth, corporate profits, interest rates and inflation that will determine the direction of markets.
Q: How can diversification help investors amid heightened geopolitical tensions?
A: Diversification across asset classes, industries and geographies can help dampen volatility during times of acute market stress. High-quality assets, including high-quality bonds, as well as other investments with a low correlation to each other can also provide diversification benefits during periods of market stress.
Q: Given all the factors driving global uncertainty and volatility, what is the CIO’s near-term outlook? Are there specific steps investors could consider?
A: We expect markets to resume a subtle upward trend prior to year-end, with solid corporate earnings and a stabilization in bond yields as the main catalysts to support equity markets. Fixed income markets are likely to price in a “higher for longer” interest rate policy that would provide attractive real yields for income-based investors. A strong U.S. dollar, oil prices that remain firm and a sentiment for higher-quality assets are also probable.
We continue to emphasize staying balanced and fully diversified as uncertainty and geopolitical risks remain elevated. But periods of market volatility such as we’re seeing now can present opportunities to rebalance, or to realign with an asset allocation plan designed for your goals.
Keeping a long-term perspective
In the midst of rising geopolitical tension, maintaining a long-term perspective can be challenging. “But now is an especially important time to avoid making sudden portfolio decisions in response to daily events,” Hyzy cautions. “We’re following events in the Middle East and around the world, and we’ll be updating our perspectives with new insights as things evolve.” In the meantime, stay focused on your goals, he advises. “If you’re working with an advisor, a conversation with them can help you determine whether any portfolio adjustments are warranted.”
1 “Why would you want to own the S&P 500 if …”, U.S. Equity & Quantitative Strategy, BofA Global Research, Oct. 12, 2023.
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