Black Swans A-Swimming
“The Black Swan” is a book by Nassim Taleb about the massive impact of rare, unpredictable events. At one point, all known swans were thought to be white until the discovery of black swans in Australia dispelled this belief. Black Swan events are characterized as being highly improbable, having a substantial impact, but being rationalized in hindsight as if they were predictable. The Middle East conflict could be considered a Black Swan event. In addition, Taleb argued recently that markets may be underpricing structural risks while overestimating the durability of today’s artificial intelligence leaders. History suggests early pioneers are often displaced.
On Monday, following the U.S. incursions in Iran over the weekend, markets started down 1-2%. However, the S&P 500 Index and the technology-heavy Nasdaq Index actually finished up for the day. On Tuesday, elevated risk to energy supplies from a prolonged conflict entered the calculus. Major equity markets were down over 2% again yesterday morning, but turned around and ended well off the lows. Tanker traffic through the Strait of Hormuz, through which one fifth of oil production flows, has all but ground to a halt. Iranian missile and drone attacks forced the closure of both the world’s biggest liquefied natural gas (LNG) facility and Saudi Arabia’s largest oil refinery. And yet while oil prices surged higher, the scale of the moves has been far smaller than in previous crises. Equity markets are starting in the green so far today.
While oil and gas commodities are priced globally, the U.S. is less reliant on oil from the Middle East, importing about 10% of our needs compared to 20% a decade ago. Looking back further, by the late 1970’s, the U.S. was relying on OPEC nations for about 70% of petroleum imports and half of U.S. consumption. The U.S. is actually a net exporter of oil now, exporting more than we import. For the seaborne gas market, the shutdown of Qatar’s massive LNG facility, which accounts for about one-fifth of global supply, is a more immediate shock. As global LNG storage capacity is much lower than that of oil, a sharp rise in LNG prices is inevitable, as evidenced by European gas prices rising 35% yesterday.
Give It To Me, Strait
A material disruption could arise if serious impediments to energy shipments through the Strait of Hormuz continue for an extended period of time, especially with the conflict widening to Iran’s other energy producing neighbors in the Persian Gulf. The Strait of Hormuz is crucial for 20 million barrels per day of oil shipments. Saudi Arabia, Iraq and the UAE together exported 13.3 million barrels per day (bpd) of oil via the Strait last year. China and the rest of Asia are the main destinations for Persian Gulf oil, accounting for 80% of total flows through the Strait. The International Energy Agency (IEA) estimated last year that only 3.5-5.5 million bpd of the oil that flows through the Strait can be redirected using existing pipelines. The U.S. can release around 1-2 million bpd from its strategic petroleum reserves, although that reserve is only about 60% full. Some estimates suggest that oil prices could rise to well over $100 per barrel, and stay elevated for a while, as it did in 2022 following Russia’s invasion of Ukraine. Currently, West Texas Intermediate oil prices are about $75 per barrel and Brent Crude is priced at about $82 per barrel. Gasoline prices are sure to follow higher, raising near-term inflation concerns.
Drilling Down Further
Year to date, the S&P 500 is down about 0.4% while the equal weighted index is up 4.8%, highlighting a broadening of investor interest in sectors beyond just technology. The S&P 500 is dominated by larger capitalization technology companies that have mostly lagged this year while the tech-heavy Nasdaq index is now down about 4% this year. Meanwhile, the 10-year treasury yield has been trending lower toward 4.0-4.1% as U.S. Treasury demand has remained strong due to safe-haven buying. While volatility will persist and uncertainty is high due to the Middle East conflict, geopolitical events have historically had limited longer term impact on U.S. financial markets or the economy.
Without resolution and in consideration of the quickly shifting dynamics, the U.S. has targeted 4-5 weeks as the base case length of time the Iran conflict could conceivably last. Already, the administration announced that it may aid tanker traffic through the Strait of Hormuz through insurance support and potentially naval escorts. Although technology, consumer discretionary and financial sectors of the S&P 500 Index are down this year, other sectors, such as industrials, energy, consumer staples and utilities sectors are all up over 10% each year to date. While we navigate the uncertainty in energy markets and other Black Swan events, there are opportunities to pick up bargains on our shopping list and participate in diversified sectors beyond technology where valuations may be more attractive. S&P 500 futures are indicated positive this morning.
Actress Patricia Heaton celebrates her 68th birthday today, and Garrett Morgan, inventor of the three-position traffic symbol, was born this day way back in 1877. Caution was added to Stop and Go.
Christopher Crooks, CFA®, CFP® 610-260-2219