Geopolitical concerns were clearly at the forefront of investors’ minds last week, as the Morningstar US Market Index fell 0.5% following Israel’s attack on Iran and the subsequent response. The impact was felt most acutely in crude oil prices, which climbed 13% on supply concerns.
Although Iran’s exports of approximately 2 million barrels of crude oil per day account for only 2% of the world’s output, a further 18% of global production passes through the Strait of Hormuz, making it a critical choke point in the global supply chain. Disruption to shipping here has long been recognized as a key risk to energy prices. Morningstar’s chief US market strategist, Dave Sekera, analyzes the potential impact of the conflict.
Higher Energy Costs Curb Growth
Supply risks were also reflected in the Morningstar US Energy Index, which rose 5.47% over the week. However, these gains should be seen in the context of a longer-term stagnation in oil prices due to concerns about excess supply and weakening global growth. As a result, the median energy company remains 7.5% undervalued, according to Morningstar analysts. There’s more analysis on the conflict’s potential impact on energy companies here.
Like tariffs, higher energy prices tend to act as a break on global growth and contribute to inflation, raising the specter of stagflation. Before Friday, the probability of this outcome appeared to be declining in the minds of investors. Both the Consumer Price Index and Producer Price Index came in lower than expected.
In a Crisis, Investors Should Stay Still
Defense stocks also rallied on the news, as investors extrapolated the impact of the immediate conflict to longer term demand for armaments. However, Morningstar’s analysts covering these companies believe that there is unlikely to be meaningful change to their fair value estimates at this point. This highlights the dangers of making forecasts during periods of volatility. Faced with a fast-moving and dangerous situation, we tend to use rules of thumb to make decisions, which can induce whiplash when things change again.
Continually changing portfolios to try to reflect each development is likely to erode our capital and cause confusion. It’s much better to accept that few of us are experts on geopolitics and are unlikely to make accurate short-term forecasts. Provided we own a well-structured portfolio that reflects our investing goals and ability to tolerate risk, the best we can do is sit on our hands and look for anomalies that could represent longer-term opportunities or immediate threats.
The Dollar’s Status as a Safe Haven
A good example of such anomalous behavior is the movement of the US dollar. Despite typically being seen as a safe haven during periods of geopolitical uncertainty, the dollar continued to fall last week, reaching its lowest point in over three years. It lends credibility to the idea of a structural change in the role of US dollar assets as the foundation of global capital markets. Although it is far too early to make this a core expectation, it reminds us of the importance of diversification in a portfolio.
The Search for Alternative Assets
Investors often discount such diversification when the environment appears positive, as they tend to drag on returns. It is therefore tempting to seek diversification in assets that can also provide a higher return. This search is increasingly leading investors to alternative strategies, particularly private assets, which are becoming more accessible beyond institutions and the super wealthy. This access is partly being achieved by investing in exchange-traded funds. Bryan Armour and Ivanna Hampton have released a video on the topic.
When gauging an asset’s benefits for a portfolio, forecasting returns is essential. This typically draws on long-term past returns as a guide, and it’s unusually difficult with private assets, due to the lack of regular pricing and the structure of the funds traditionally used to access them. Morningstar equity strategies principal Jack Shannon explains these challenges.
While private assets and other alternatives may have a place in portfolios, investors are fortunate that traditional diversifiers, such as overseas stocks and conventional and inflation-linked Treasuries, continue to offer some value with low investing costs.
Where Next for US Interest Rates?
Alongside the geopolitical uncertainty, this week, investors will be monitoring the Federal Reserve’s latest meeting. Despite renewed calls for deep interest rate cuts from President Donald Trump, the consensus view that rates will remain unchanged hardened last week.
As central bankers typically consider the inflationary impact of energy prices when making decisions, it seems unlikely that the current conflict in the Middle East will impact this decision. Senior Morningstar reporter Sarah Hansen previews the meeting.
An Investing Handbook for AI
Away from geopolitics and macroeconomics, artificial intelligence remains one of the key themes for both companies and investors. To help cut through the noise and understand the options available, Morningstar EMEA manager research principal Kenneth Lamont has published an AI investing handbook.