What has happened?
- On October 7th, the militant Islamist group Hamas fired missiles from Gaza and sent its fighters into Southern Israel, prompting Israeli Prime Minister Benjamin Netanyahu to declare war.
- As of October 9th, reports indicate that the conflict has resulted in over 700 Israeli casualties, primarily citizens, and 500 Palestinians killed in retaliatory attacks.
- Israel has announced its largest-ever mobilization of more than 300,000 army reservists.
Where is Gaza?
- Gaza is a territory bounded by Israel, Egypt, and the Mediterranean Sea that has been controlled by Hamas since 2007.
- It is a refuge for 200,000 Palestinians uprooted by the Arab Israeli War of 1948 and is one of two territories, along with the West Bank, where Palestinians exercise limited self-government.
- Gaza has been the focal point in Israel’s ongoing military conflicts with the Palestinians.
What is likely to happen next?
- According to our third-party research provider, Israel is actively working to secure its borders with Gaza as well as enhance security within its own borders.
- The next phase is likely to involve ground incursion into Gaza aimed at dismantling Hamas’s military forces, likely requiring a lengthy effort.
- While Israel is focused on Gaza, expansion points include an uprising in the West Bank, resistance in Jerusalem, and the response of Hezbollah, a Lebanon-based Shia terrorist group more formidable than Hamas.
How does this impact geopolitics?
- The period of geopolitical moderation may be ending, posing complicated implications for global capital markets.
- Because the world is moving toward a more fragmented environment, intense competition between major world powers leads to less cooperation on global issues.
- A more fragmented and less coordinated world may result in higher costs of capital.
How does this impact energy markets?
- Israel is a modest producer of natural gas yet not a significant producer of oil.
- The current conflict, thus far, appears focused on the immediate region of the Hamas stronghold, which is not an oil-producing region.
- While both oil and natural gas prices have risen, this conflict is unlikely to have a significant long-term impact on energy markets, as there is not likely to be a sustained disruption to oil and gas markets, and the world maintains sufficient spare capacity.
- The alleged involvement of Iran in these events may reduce its oil supply to markets, yet the extent remains uncertain.
- Our third-party research provider’s base case calls for immediate price increases for energy that fade over the medium term.
- A left tail risk where this geopolitical shock occurs alongside significant supply disruptions would likely have profound implications for energy prices should the war escalate outside of Israel, yet this is not the base-case scenario.
What are the implications for equity and fixed-income markets?
- As is common with geopolitical shocks, we anticipate a flight to quality into U.S. Treasuries and other safe-haven assets over the short term.
- The potential impact to broader equity markets is difficult to predict because the risk of a wider conflict involving Iran and other Israeli enemies is difficult to assess.
- Still, the risk of elevated equity market volatility appears likely in the near term.
- The greatest risk of an energy supply shock would likely impact fixed-income markets, with global central banks possibly tightening monetary policy in response to supply disruptions and rising inflation expectations. This could lead to higher long-term yields, given increased inflation risk premium.
- In such a scenario, the correlation between equities and fixed income would likely break down, diminishing the effectiveness of diversification.
What are the implications for client portfolios?
- The Investment Management Team has assessed our exposure to Israel within our international equity strategies and taken steps to liquidate our exposure to iShares MSCI Israel ETF at market open.
- Our buffered note and FLEX positioning should help mitigate downside volatility within our equity portfolios.
- We continue to recommend equity market participation, as equities have historically held up well during geopolitical shocks and in the months thereafter.
- Heightened volatility may prove to be a catalyst for the redeployment of FLEX back into equity markets at attractive valuations.
- We continue to advocate for a long-term investment approach, as short-term missteps in this environment may carry enduring negative effects on client portfolios.
Investment advice offered through CX Institutional, a registered investment advisor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.
The third-party research provider referenced includes Blackrock’s views as of October 9th.