Markets understandably took the attacks on Iran poorly, especially after the closure of the Strait of Hormuz sent oil, gas and many other raw material prices soaring. After the initial swoon, with the commodity prices fluctuating on every move and counter move coming from the United States, Israel and Iran, the market started to look through the geopolitical backdrop. Despite there being no end date in sight, it appears that Donald Trump is trying to engineer an elegant exit, without seeing that he has failed in his initial mission.
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Richard Scrope
Fund Manager
What crisis?
Can the world do without Arabian oil?
As the calendar turns into the first quarter reporting season, all eyes have been on the commentary surrounding the impact of the ongoing tensions in the Gulf region. For even the most geographically diverse companies, the Middle East constitutes only a small percentage of sales, and the inflation in input varies markedly by industry.
The experience of the pandemic, and the disruption of supply chains that ensued, taught management teams of the folly of single source suppliers and not building in resilience to their models. Although in the case of oil and gas, especially to Asia where most of the Gulf oil ends up, it is difficult to make up shortfalls from other regions, it is not impossible, and the US and Canada are increasingly becoming net exporters of these vital commodities.
Although without the supply from the Gulf region coming back on stream, prices will remain elevated and are unlikely to return to the levels seen at the start of the year as repositioning oil tankers and contracts to alternative suppliers is fraught with difficulties. Certain industries are already changing their production patterns to fit better with what they see as their input good availabilities are estimated to be. If you have booked flights over the summer, you might need to double check your booking as jet fuel is already in short supply, exacerbated by the amount being consumed by the warplanes circling over Arabian skies; Lufthansa recently announced the cancellation of 20,000 short-haul flights due to this issue, and many others are following suit, or increasing fares to cover the increased costs.
Quarterly earnings calls are revealing.
The first quarter results, however, have been remarkably upbeat thus far, although there are many comments about ‘uncertainties’ and ‘closely monitoring the situation’. Led by the semiconductor space, for which there appears to still be an insatiable demand, growth has been even stronger than many analysts expected with almost 30% earnings growth in aggregate from those US companies that have reported thus far.
Rather than the last couple of years, where almost all of the growth came from a small handful of companies, what is noticeable is that the breadth of the market has improved demonstrably, and thus the increase in valuations has better footing.
In Europe, where there is more exposure to commodities coming from the Middle East, the aggregate earnings growth has been similarly strong, but the make up of these returns has been very different, albeit the region is much earlier in their reporting season than their US counterparts.
Can markets valuations continue to be unfazed by the Middle East?
As forward-looking instruments, equity markets, appear to be looking through the current turmoil, volatility has subsided and many markets are back to or above levels when the attacks started. The breakdown of company results remains insightful to where demand is coming from and which pockets of the market appear to be improving and those which are not. At this time opportunities have, and continue to emerge for active investors, and much like in the aftermath of the pandemic’ great long-term investment can be made for those investors who are not fixated on the geopolitical uncertainties, which may or may not continue for longer than Donald Trump hopes or initially intended.
Data source (unless otherwise stated): Bloomberg
Disclaimer
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