The recent escalation between Israel and Iran has caused a sharp drop in share prices this week, attributed partly to profit-taking and Iran's direct attack on Israel, leading to market uncertainty.
The recent escalation between Israel and Iran has caused share prices to drop sharply this week. While some of this can be attributed to natural profit-taking, given that share markets have increased over 10% in the last six months in both Australia and the USA, the significant drop in share prices is also due to Iran’s latest direct attack on Israel. This marks a first in recent history and has understandably caused some uncertainty in the markets.
As a result of this conflict, oil prices have surged to a six-month high, and gold, traditionally a safe haven in times of crisis, has risen approximately 4% in the last week. Interestingly, shares in gold miners have remained stubbornly low, a trend that has been continuing for the last 12 months. Bitcoin has also taken a hit, down 7% in the last few days.
From a finance and investment perspective, there are three potential scenarios that we can foresee. It’s important to note that these scenarios are discussed purely from a financial markets perspective, not a humanitarian one. It’s crucial to separate these two issues when discussing these options.
Scenario One: Return to Normalcy
The best-case scenario is that there’s no further conflict and things return back to normal. This, combined with Israel withdrawing from the Gaza Strip, should hopefully ensure that fears subside about oil prices going up and inflation. Consequently, interest rates should come down as well. We also hope to see a cessation of attacks on shipping within the Suez Canal by the Houthi rebels in Yemen, which will also help bring inflation down. However, we feel this might be a little optimistic.
Scenario Two: A Protracted ‘Tit-for-Tat’ War
This scenario involves a protracted ‘tit-for-tat’ war, which drags on with no significant loss of life or infrastructure. From a financial markets perspective, we view this as a worst-case scenario. The constant fear of a full breakout of war will push oil prices up and continue to drive inflation. This will further increase tensions on both sides and continue to cause concern and uncertainty about what will happen next. In this scenario, we foresee that inflation will remain somewhat high, and consequently, prices will continue to increase, and interest rates will remain high for longer.
Scenario Three: A Full-Scale War
A full-scale war will send share market prices crashing, which is always a short-term significant shock. However, this can be combined with interest rates dropping, which would increase the funding ability for businesses. Sharp corrections in the markets can provide opportunities, especially for accumulators. For example, from the bottom of the COVID-19 crisis to the top of the recovery, we saw some of our clients increase their portfolios by approximately 50%. So, if you are in the accumulation phase, this could present a phenomenal opportunity to build your portfolio, assuming that we do come out on the other side. Of course, for retirees, this is probably a worst-case scenario and an opportunity to determine whether your current asset allocation is appropriate for your situation.
In conclusion, while we have no control over the market, we can control our reactions, emotions, and decisions. It’s good to ponder what you would do if each of these scenarios occurs. If you’re someone who’s not comfortable with a 20% drop in your portfolio, it’s essential that you’re not in an investment option which could realistically have a 20% drop in a short period of time. These are all important discussion points for your financial planner to determine what risk you’re willing to take to increase your returns.
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