This week Gary focuses on the impact of the events in Iran on the markets. With around 20% of the world’s oil and liquified natural gas (LNG) flowing through the Strait of Hormuz, there’s been a surge in oil prices, which could have an inflationary impact. While equities have remained resilient over the past week, crude oil futures are up around 20% and the VIX index, which measures volatility, is also up. Watch the full video for Gary’s analysis:

TRANSCRIPT:

Hello, everyone. Welcome to the 7 Market Movers. My name is Gary Quinzel with Wealth Enhancement. Before I dive in on today's topic, I wanna first address the human reality of what's happening in the Middle East.

As we all know, war brings real suffering and a lot of uncertainty, and the events unfolding in the Middle East are certainly tragic and very serious, and our thoughts do go out to all of those that are directly impacted. With that said, our role today is to address and unpack what this means for the markets and for our investors. So the key right now is all about the impact to energy prices, also its potential inflationary impact. So with that, let's go ahead and talk about the market's reactions so far.

If you take a look at what's happened with oil, we've seen quite a surge. If you take a look at WTI crude, it's up around 20%. Since Saturday, we've seen Brent go up around 18%. Equities by comparison have been relatively resilient.

If you take a look at S&P 500, it's down only around 0.7%. Now it was down a little more. It rallied a little bit, but we're seeing the international stocks be hit a lot harder. So if we take a look at the MSCI EAFE index, it's down over 5.4%.

Now why is that? I think the obvious reason is simply that those it's made up of a lot of countries that are more directly impacted, a lot closer in proximity to the conflict, and they rely a lot more on the energy that's flowing through the Middle East. I noted that volatility has picked up. We've seen the VIX index go from 20 to roughly 25, which is definitely heightened but not at extreme levels quite yet.

Probably the most interesting reaction has probably been in treasuries. Now normally when you have some of these crises, these geopolitical events, investors flock to safe haven assets. They buy bonds, which pushes yields down. We're actually seeing the opposite of that right now.

We're actually seeing yields go up, which is quite interesting. It actually tells us that investors are not pricing in a worst case, worst scenario. They're actually pricing the potential for higher inflation or they're predicting that we could actually see a longer term disruption. We don't know yet, but we could see a disruption that could lead to potentially higher inflation.

So it's really an energy driven repricing as opposed to a liquidity concern or liquidity event thus far. So I'm gonna talk a little bit about why oil is the transmission channel because it's not about GDP. It's certainly not GDP related to Iran. But if you think about the amount of oil that flows through the areas, particularly the Strait of Hormuz, roughly 20% of global oil and liquid natural gas does flow through the Strait.

And so we note that tanker traffic remains very, very vulnerable, and we estimate that it's a very significant portion of, particularly of Brent crude, remains very vulnerable and it's already reflecting that war related risk premium. So now here we are, day six of the conflict. We do lay out three potential paths for oil. The most ideal path would be an immediate ceasefire, which doesn't seem imminent, but that could bring oil prices back down.

The base case probably is at a sustained conflict, where we see oil stabilize around current levels possibly a little bit higher. The worst case scenario, of course, is a more sustained disruption that could continue on for weeks, if not months, and that could push oil significantly higher from today's level. And if oil does remain elevated for a sustained period, we do have some historical evidence that suggests that for every ten dollar increase in crude oil, we have seen up to a 0.4% increase in inflation as well as a 0.1% to 0.2% decrease in GDP as an impact.

And so this creates a little bit of a tension and headache for the Federal Reserve, which as we all know is expected to cut rates one or two times later this year. However, they have a dilemma on their hands now because of higher oil will push inflation expectations up. We're already seeing that in the breakeven inflation rates that could encourage the Fed to hold off or worst case raise rates, and we're not expecting them to do that, but that's the reaction to higher, inflation. On the contrary, higher oil also has potential to slow growth, which typically leads to central banks to look through the shock.

So right now, we're in that risk premium phase where the market is really just assessing what this all means. They're not in a structural supply shock phase, and the market is asking, is this temporary or is this more of a permanent regime shift? And time will tell, but we're certainly paying a lot of attention to that.

On a positive side of things, the US has entered this from a position of strength. If we look at a variety of macroeconomic indicators, the US economy is certainly not fragile going into this. As we've talked about in the past, labor markets remain very resilient.

We've noted that layoffs are contained. Productivity overall has improved. A lot of that is due to the AI factor, and a lot of artificial intelligence investment continues. We also note that from a consumer standpoint, we're still seeing a resilient consumer, a lot of spending, and balance sheets over balance sheets overall are stable. You know, just to wrap things up here, it's important to note that energy supply shocks often tend to be narrow and short lived and and usually with limited sustainable pass through to core inflation.

In many cases, the inflationary impulse is partially offset by the dampening effect that higher energy prices bring to overall economic activity. So for clients that are concerned about rising prices, it's important to note that equities often remain one of the most effective ways of long term hedge against inflation as companies always have the ability to adjust their pricing and margins over time. Now owning equities inherently brings on volatility, that's just a feature of the markets, particularly during these geopolitical episodes. So when it does happen, and it's happening now and it'll happen again, it serves as a constructive reminder, an opportunity to rebalance your portfolios opportunistically back to your strategic targets, harvest tax losses where appropriate, and deploy capital for investors who have been under allocated.

Now, the duration and trajectory of this conflict remains very uncertain, but what is under our control is portfolio discipline. History suggests that making material changes to our long term strategic asset allocations in response to short term events is rarely rewarded. So as I said, in this environment, discipline matters, volatility is inevitable, panic is optional, and history continues to reward patience and process. So with that, I hope you found today's update useful.

As always, if you have questions, please reach out to your financial advisor. Thanks for tuning in. Hope you have a great day.

This information is not intended as a recommendation. The opinions are subject to change at any time and no forecasts can be guaranteed. Investment decisions should always be made based on an investor's specific circumstances. Investing involves risk, including possible loss of principal. 

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