Markets and the Middle East

0:05Pushkin. The news from the Middle East is relentlessly grim and getting worse and yet markets are more or less taking it in their stride. Stocks are holding on okay, certainly not crashing. Oil is up a bit, but not dramatically, so we're not pricing in a blockage in supplies from the region. Gold, a classic haven, is going nowhere, but to be fair, it has had an amazing run recently. And the dollar is up a bit, and if anything, bonds are weakening. So pretty much business as usual. Today on the show, we're asking, do investors not read the news? And if they do, why are they so chill? This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin.

0:54I'm Katie Martin, a markets columnist here at the FT in an increasingly chilly London. And I'm joined down the line from New York by one of the FT's premium mumblers, which could be fun for a podcast, Nicholas McGaw. Nick, how are you doing? I'm all right. You're not allowed to mumble. I'm just going to try and get through the whole thing without even opening my mouth. now listen so are investors more cheerful than they sort of generally let on are they the world's biggest optimists here what's going on they're not in person if you actually talk to them people one are obviously concerned about the state of the world they are human ish humanoid but also you get a lot of talk about how they're concerned that all of this could have massive ramifications for markets and like every big asset manager is hiring like former nato generals and every conference i've been to in the last 12 months is full of like foreign ministers and political advisors trying to teach people who understand foreign policy yeah but then they're just not trading on any of it so the line that fund managers have been coming up to me with like for the whole of this year the whole past 12 months really is this situation is bad and what we don't want is for it to escalate and what we don't want is for Iran to get directly involved and that now has obviously happened but even after that like we were saying at the top like there is a market reaction it's just not huge so what do we think is the primary reason for that I mean part of it is it doesn't matter how many former NATO foreign policy wonks you have advising you we just don't know what's going on right yeah there's a certain amount of just uncertainty and there's like a psychological point right of you don't want to be the first person to sell like if the entire market crashes because of world war three you know you dust yourself off and go again but if you sell because you're concerned and then the market rallies you lose your job so if no one else is panicking you just kind of feel uncomfortable but have to stick with it i think from my conversations with people in the market, the thing that would make them not take this more seriously, but take this more seriously as a market moving event is the oil price, right?

3:14And even there, we're under$76 a barrel on Brent. We're at the highest since, I don't know, last week sometime. There has been a pickup in prices, but it's just not that dramatic. You compare that to what happened with Russia's full-scale invasion of Ukraine two and a bit years ago, and we're just not in the same territory, right? Yeah. Although even then, that had a big impact for a couple of weeks and then came back down. Like oil now is cheaper than it was at the end of 2021, which feels wrong considering there's two massive conflicts going on. The longer term comparison that people bring up a lot is they talk about like the 70s and oil price shocks can have a massive impact on the economy.

3:54And that's what would really hurt the US market is like, if you start damaging the US economy, we've had a kind of fragile recovery. But the difference with the 70s is the largest oil producer in the world is the USA. So like, it's just way better insulated from a shock in the Middle East than it used to be. So there's the US bit is one half of this. And I guess another is that as I understand it, and I'm not an oil market expert by any stretch of the imagination, but Iran is a much smaller producer than Russia. So if you can effectively take Russia out of the international oil market, then you can afford to lose Iran if it really comes to it.

4:33And as you say, you know, America is already a massive producer of fossil fuels. And there's lots of, again, not an expert in the oil market. But again, as I understand it, there's lots of like shale pipes that have been dug into the ground and sealed off that you could unseal pretty quickly and get them pumping if you really needed to and if you really needed to bring up supply. So yeah, it's just not the same equation at all, right? Yeah, like in the US, especially if there was a massive spike in oil prices, people could just kind of turn the taps back on. Like the whole thing in the shale sector in the US in the last couple of years is that they used to just pump all the time, and then it made the oil price go down, and then they all went bust.

5:14So they've now got much more sensible, but the infrastructure is still there. So if there's a way to make money with it, then they will. And also, again, similarly not an expert on commodities, but other countries in the Middle East are concerned about market share. Like the Saudis would like to keep their market share. They're not actually trying to push the price as high as possible. So there's other sources of supply around. And if there was like another major escalation of some sort, and no one, certainly not I, but no one really knows what's going to happen next. It's that massive pickup in an oil price that is a danger.

5:50And particularly, I guess, in the sense that the real danger is that it could push up inflation again in the states. And as far as the Federal Reserve is concerned, it's fixed inflation now. Thanks very much. We've moved on to worrying about the jobs market. So if we all have to go back to worrying about inflation again, then it's going to feel a bit Groundhog Day, isn't it? Yeah, basically, it's inflation. And I mean, people like to try and shrug off inflation caused by energy. And I think they overdo it because they'll be like, oh, no, but like core inflation is still fixed. But if you're a man on the street, actually, energy inflation is the thing that you feel the most.

6:26Because when you go and fill up your car, which everyone in America has, so they feel it. They also have less spending money and then it has knock on effects and they don't spend money on other things. So actually, yeah, oil price inflation could be really damaging. Price at the pump and all that is like a really big deal politically in the States in a way that it just isn't over in the UK. Especially like three weeks before a presidential election. Yeah, you've got some sort of democracy going on over there. We'll have to talk about that another time. In amongst all this, I mentioned the Federal Reserve.

6:57I think that's the other thing that is really pushing in the opposite direction to any nerves over the Middle East, right? in the sense that only a couple of weeks ago, the Fed came out and cut interest rates by fully half a percentage point, which is a lot more than it usually cuts or raises by, but also did this like magic trick where it managed to convince investors that, look, we're not doing this because we think there's going to be a recession and we're really nervous about stuff. We're doing this because we can. And that is just like manna from heaven if you are in risky assets, right? So you've got easing monetary policy.

7:30You've got limited risk of a recession. happy days right if you're in equities if you're in corporate bonds and you know i guess we're just not seeing enough yet from the middle east to act as a massive counterbalance to that kind of melt up uh you know good vibes yeah i think especially at like the index level monetary policy and a bit of like ai madness is what has been moving the market broadly for the last couple of years and And it'll take more than a few days of geopolitical concerns to change that. There's a little bit more stuff under the surface, like defense contractors, slightly grimly did get some big moves.

8:13But they're not big enough to move the S &P 500. Yeah. And the Middle East story does nothing to like AI and tech stocks that immediately springs to mind. So that's why it is weird when you have this business as usual kind of vibe. Because as you say, like fund managers are people too, almost all of them. They get the human side of this story and they get how horrible it is, but they just don't see a way to translate that into moving stuff around in your portfolio yet. It's funny because sometimes it feels almost like they want to be doing more and they are uncomfortable with it. Like BlackRock did a whole, you know, like they've added it to their list of big risks.

8:52And Larry Fink has talked so much about how he was really concerned about how we're moving into a whole new period of not just the Middle East, not just Russia, Ukraine, but all sorts of unpredictable political risks. And then they did a big study to kind of back it up. And it was just like, oh, it turns out politics doesn't tend to move markets that much. Everything is always the Fed and inflation. You know, it kind of feels like to a certain extent we're going around in circles. Yeah, this is me trying to find a different way to say that in every story that I write this year. Say, you know, let's be optimists.

9:23Assuming things don't get worse, what do you think is going to happen sort of between now and certainly the US election? Do you think we just sort of tread water? Do you think markets pick up? Or do you think they sort of stay really nervous? I think in the very short term, just because the election is coming up as well, you'll probably get a little bit of volatility. But in the same way that earlier this week, we had, you know, an orderly risk off day. And then markets were flat the next day. I don't think there would be wild, wild swings. So one thing that this reminds me all of is that when Russia properly invaded Ukraine in 2022, people were, you know, people in markets in the West were like pretty much universally saying, this is a terrible thing.

10:11And I don't mean to sound awful, but the Ukrainian economy is just not that big. It's not like a major part of anyone's portfolio. That's not really the issue here. And I wonder, like, it's pretty similar with Israel and Lebanon and Iran, right? These aren't kind of globally significant economies in and of themselves. They're just not big enough. So what are the ways in which this could get nasty for the global economy? The most obvious mechanism or the one that people in the US at least talk about the most would be the oil price because that is something that is more deeply tied to the conditions in the Middle East than the broader global economy is.

10:52But again, even there, we're not talking about the biggest producers. I don't want to predict. I'm sure there are all sorts of ways that you could cause a bigger impact on prices, but even that so far has been relatively small. But that's the one that people talk about the most. That's the thing that worries them. Maybe second on the list is something around shipping, right? There have been disruption to shipping earlier this year caused by groups that are sympathetic to one party or another in this conflict, let's say. Is there a risk that that could come back as an issue, do you think? I think so.

11:26You get, again, partly by impacting oil prices if it's oil tankers that get affected, but also kind of flashbacks to COVID where you saw delays to moving goods around has massive knock-on effects on supply chains. It hits manufacturing. It can hit consumers if they can't get the stuff they want to buy. So that is a potential one, I would say. Yeah. But, you know, broadly speaking, it is a case of sort of sitting back and it sounds terrible, but just waiting for this to get worse right yeah from an investor standpoint there's not much reward for moving too early on this yeah it's a pretty uh it's a weird situation to be in right i don't envy the portfolio managers that could end up taking a hit from this nick you've done very well without mumbling but we're going to be back in a sec with long shorts

12:28Alrighty, it's time for Long Short, that part of the show where we go long a thing we love, short a thing we hate. Nick, what have you brought to show the class? I'm going to go long the VIX. What is the VIX for the uninitiated? The VIX is impossible to reference in a newspaper article without using the words Wall Street's fear gauge. It really winds people up in markets when you call it the fear gauge, but fundamentally that's what it is. It's a proxy for implied volatility in the S &P 500 over the next 30 days. But like it shows whether people are scared or not. so having just spent the entire podcast talking about how markets are chill i'm actually going to predict that implied chillness at the very least is gonna fall in the next couple of weeks because people are getting worried about the election and people are expecting other people to get worried about the election and it kind of in a way is almost feels like a dumb trade because it's so obvious but like the week before the election people start worrying about the election and so the vix spikes and so people are like buying vix contracts now in the assumption that they will be worth more in three weeks does this make sense to you do you think it's a good thing to do i think trading volatility is easy to get wrong because you can mess up your entry point and end up losing a load of money even if your actual thesis is right so i don't know about the specific trades but broadly will i end up having to write something about how shock the vix has risen the week before the election probably yeah almost certainly may as well start pre-writing it now make sure you get in there that it is wall street sphere gauge i am short so i've been back on my bike this week after a little hiatus for various boring reasons and there was just so many idiot cyclists on the road and I'm sure all of them I'm particularly sure people on electric bikes who don't think that traffic lights apply to them and if I get knocked off my bike by an electric bike I will be extremely cross about it but ultimately have no recourse are electric bikes a big thing in New York they are because there's electric city bikes now and so it's extremely frustrating when you're like wheezing and carrying your laptop and you're halfway across like the Brooklyn Bridge and then someone in a suit on an electric bike and no helmet just comes whizzing past you and also I don't know how where we're making new ones because I assume these people are dying at an incredibly fast rate yeah I have a near-death experience every time I cycle in New York and I'm incredibly cautious so how these people are surviving is a mystery to me I'm glad that I've triggered you with this subject let's stop beating up on other cyclists now cycle safe everybody and we will be back in your feed on Tuesday so listen up then Unhedged is produced by Jake Harper and edited by Brian Erstad our executive producer is Jacob Goldstein we had additional help from Topher Forges Cheryl Brumley is the FT's global head of audio special thanks to Laura Clark Alistair Mackey, Greta Cohn and Natalie Sadler FT Premium subscribers can get the Unhedged newsletter for free.

15:50A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

16:16Just mutter angrily about Katie Mayer and Martin making fun of me again, stealing my jokes. Doesn't matter, it's fine.