Just as Pentagon planners are sorting out military contingencies in the event of a conflict with Iran, so too are investment planners assessing the investment risks and opportunities of war in the Persian Gulf.
A new investment commentary by analysts at Wilmington Trust, the more than century old high-net-worth outfit the DuPont family founded to manage its own wealth, considers the market effects of an Israeli response to Iran’s efforts to complete its nuclear program.
Wilmington Trust’s Clayton Albright III and Clement Miller start their analysis noting today’s high gas prices, heading to the peak levels seen in 2008 and 2011—a fact they tie to the geopolitical situation swirling around Iran’s nuclear program and Western efforts to contain the crisis through economic sanctions. Rather than “fear the worst and react accordingly,” Albright and Miller attempt to coolly lay out four scenarios they consider realistic, only one of which (and not the most likely) they consider to be seriously destabilizing.
The first scenario they consider realistically possible is a continuation of sanctions with no overt military conflict—in other words, today’s status quo will persist. Under that scenario, to which they assign a 20% probability, investors should expect “continued upward pressure on oil prices.” The efforts of the U.S., EU and soon Japan to ban new oil contracts and phase out oil purchases under existing agreements are tending to reduce Iran’s participation in global oil markets, despite the slack picked up by China, India and other emerging market Iranian customers.
Moreover, supply disruptions and low surplus production are occurring at a time of historically high levels of global oil consumption. The result, the analysts foresee under this scenario: “A prolonged period of high crude oil prices would present a continuing drag on the world economy and on expected equity market returns.”
A second scenario, to which Albright and Miller also assign a 20% probability, involves an Iranian attempt to curtail oil shipping. An offensive military action by Iran, such as closing the Strait of Hormuz, would actually present an opportunity to prepared investors. The analysts cite military sources who believe the U.S. will be able to repulse Iranian aggression and restore order within a week or two. Since many will likely panic and sell their investments, the Wilmington Trust paper advocates patiently awaiting the positive outcome of the crisis, or even adding to “equity and credit risk where appropriate.”
The most likely scenario Wilmington Trust anticipates is an Israeli and/or U.S. bombing campaign that sets Iran’s nuclear program back a few years and inflicts damage on Iranian military capabilities. This scenario, to which they assign a 40% likelihood, has the same advantage of the second scenario: a quick return to normal, within weeks, offering investors to buy the panic. The analysts’ worst-case scenario, which they consider to have a probability of 20%, would be a bombing campaign that “prompts an expanded Iranian-U.S. military conflict, drawing in Arabian Gulf oil producers and resulting in the destruction of key oil facilities.” Alblright and Miller note there a number of Arab Gulf states that enjoy U.S. protection. “Should Iran successfully manage to curtail oil production on the Arab side of the Persian Gulf, oil prices would sharply rise, likely leaving a severe dent in the global economy.”
Wilmington Trust currently has “below benchmark allocations to the overall equity market and to non-U.S. equities” both in response to the prospects for conflict in the Middle East and because concerns about a severe recession in Europe.
Because the investment company considers the most likely outcomes to include U.S. and Israeli forces prevailing, “a brief spike in oil prices and a temporary drop in equity markets,” a Middle East conflict would present an opportunity to “raise our equity stakes at better prices.” In the event their worst-case scenario transpired, “we might trim our equity and credit exposures in favor of core fixed income and cash.”