Is the United States heading towards a government debt crisis?
The Middle East erupted in conflict over the weekend of 28 February following joint US-Israel air and missile strikes on Iran. In response, Iran fired missiles at a clutch of neighbouring countries including Saudi Arabia, the United Arab Emirates, Qatar, Israel, Bahrain, Kuwait, Jordan, Oman, and Iraq, as well as Cyprus, which hosts British forces.
Unsurprisingly, oil prices have spiked, share markets have weakened while government bond values strengthened, and the gold price, which has been on a tear over the past year, took another step forward in price.
As to where financial market judgments may land in the coming weeks, assuming the war lasts for some time, we may draw some learnings from last June’s 12-day clash between Israel and Iran, and Russia’s 24 February 2022, invasion of Ukraine.
Like now, share markets initially weakened, but later stabilised as investors concluded that the conflicts would be contained.
Energy market impacts
That said, disruptions to global energy supplies are the most worrisome immediate economic consequence of the current conflict. Iran and its Arabian Gulf neighbours astride the Strait of Hormuz, one of the world’s most important oil choke points.
About 13 million barrels a day of crude oil transit the Strait of Hormuz, representing around 31% of global seaborne crude flows.1 Moreover, Iran’s neighbours, such as Qatar, are some of the world’s largest gas suppliers, with roughly 20% of liquefied natural gas (LNG) exports passing through the Strait.2
Shipping through the narrow waterway appears to have fallen drastically and no immediate replacement gas sources are available raising the possibility of price spikes for Asian and European customers. A bad economic scenario would be the potential for inflationary pressures to rise again, weakening the world’s economic pulse.
OPEC increasing oil supply…
Oil producers are very mindful of the harm that would follow a period of disrupted supply and the Organisation of Petroleum Producing Countries (OPEC), and some non-OPEC nations, agreed on Sunday 1 March, to add a little over 200,000 barrels a day of supply.3
Saudi Arabia, Iraq, Kuwait and the United Arab Emirates had already begun increasing oil shipments in the previous month, mirroring the export ramp up seen during last June’s US strikes on Iran’s nuclear facilities.1
This good news needs to be tempered by the fact that the increased supply will need to find alternative and more expensive ways to reach global customers if passage through the Strait of Hormuz remains severely restricted.
…and oil prices can move in unpredictable way
Investors may also recall what happened to oil prices over the course of the 1980-1989 Iran-Iraq war as the two protagonists attacked each other’s energy infrastructure and tanker fleets came under fire.
Despite being one of the longest and most destructive oil region wars in history, the period coincided with falling, not rising oil prices. Initial supply fears quickly gave way to weak demand, rising non-OPEC production and the loss of OPEC pricing discipline with prices declining over 1982-1985, culminating in the 1986 oil price collapsing to below US$10 a barrel.2
The episode shows that geopolitical conflict alone does not sustain high oil prices unless it coincides with tight global supply and strong demand. Instead, there was a powerful global response from new production outside the conflict zone, higher output from other OPEC members, and policy liberalisation in the US oil market, which increased production and pushed prices down.
Diversification remains a cornerstone of our investment approach. By spreading investments across various asset classes, it means portfolios are not overdependent on strong returns from a handful of assets for performance. Instead, returns are accumulated from multiple sources.
Furthermore, in volatile periods, better returns from some parts of portfolios, can potentially offset weaker returns from other parts, which helps to smooth returns.
We are strong advocates of active portfolio management because markets move and change, and psychological factors can cause hasty actions by some market participants. This creates opportunities for those who can look through events and buy good assets at attractive prices.
Sources:
1. Markets brace for impact following U.S. military strikes against Iran
3 Ibid
4 Ibid
4 The double-edged crisis: OPEC and the outbreak of the Iran-Iraq war, by Avshalom Rubin, Middle East Review of International Affairs, Vol. 7, No. 4 (December 2003)
Brief history of market corrections
Over the past 50 years, the ASX has seen several significant drops1:
1987 crash (Black Monday)
On 20 October 1987, the ASX 200 fell 25% in one day – one of the biggest one-day drops in its history1. Despite the drama, the market reached its low within a month and recovered to pre-crash levels in around 2.5 years.
Dot-com crash (2000-2002)
Driven by speculative tech stocks, the ASX 200 declined about 22%, bottoming out over two years. It took around three years for the losses during the dot-com crash to be erased.
Global Financial Crisis (2008-2009)
The ASX 200 dropped 54% over approximately 17 months. But investors who held firm saw markets fully recover within about five years.
Similarly, global markets have historically reflected the same resilience2:
COVID-19 crash (2020)
In the US, the S&P 500 and Nasdaq fell roughly 34% and 30% respectively between 19 February high to the 23 March bottom2. However, both bounced back to pre-crash highs within about six months, driven by rapid economic intervention.
European Debt Crisis (2011-2012)
The Euro Stoxx 50 declined around 35% over two years due to a slew of sovereign debt concerns. Yet, within three years, markets fully recovered.
Despite the panic surrounding market crashes, the long-term picture tells a different story:
- Australian equities have delivered an 8.33% total return over the past 25 years3.
- Global equities have returned 8.60% annually since 19874.
In other words, markets recover, and disciplined investors are rewarded over time.
What triggers market corrections?
Market corrections are usually triggered by a combination of economic, geopolitical and financial factors. Common causes include rising interest rates, economic recessions, unexpected geopolitical events or simply excessive optimism leading to speculative bubbles. Understanding that these triggers are often temporary can help ease anxiety and encourage discipline in your investment strategy.
Some common mistakes investors make
During market downturns, investors commonly make emotional decisions that can negatively impact their long-term returns:
Panic selling
Selling out of fear locks in losses and prevents investors from benefiting when markets recover.
Trying to time the market
Predicting short-term movements is nearly impossible. History shows that investors who stay invested tend to achieve better long-term results.
Drastic asset allocation shifts
Making sudden changes – such as shifting large amounts from one asset class to another – can derail a long-term strategy and reduce future returns.
Halting regular investments
Many investors consistently add money during market upswings but hesitate when prices drop. However, adding to your investments during downturns may help you to improve your long-term returns when markets rebound.
Holding too much cash
While having a cash buffer is important, keeping too much on the sidelines may mean missing out on potential market recoveries and long-term growth.
Making any of these mistakes, or a combination of them, can significantly hurt long-term returns. Investors often panic during downturns and chase markets after they rebound, missing some of the best days of performance in between.
The power of diversification
By spreading investments across various markets, sectors and regions, you may avoid the worst impacts of any single downturn. Diversified portfolios, especially those with global exposure, are historically better positioned to absorb shocks and recover more quickly.
Turning downturns into opportunities
When markets fall, adding steadily to your investments (known as dollar-cost averaging) allows you to gain exposure to more of your preferred investment for less. For numerous historical reasons, those who stay invested during downturns tend to see stronger long-term returns3. Note that here, we are talking about staying the course in your long-term investment strategy during a downturn and not about dip-buying. The latter strategy is both very difficult to execute and could cost you a small fortune in fees.
As Warren Buffett famously put it: “The stock market is a device to transfer money from the ‘impatient’ to the ‘patient’.”
Stay calm, stay invested
The next time markets wobble, remember that market corrections aren’t disasters. They’re part of the journey. By sticking to your investment strategy, with broad, diversified exposure, you’re positioned well for long-term growth.
Stay calm, stay invested and stay diversified. If history is any guide, patience and discipline will be rewarded.
