The Hamas-Israel War and your portfolio

The Hamas attacks on Israel on 7 October were terrible and terrifying, with at least 1400 Israelis massacred. Israel has responded by placing Gaza under siege, with further military action looming – and further deaths. The Hamas-Israel War is a humanitarian disaster, and we should all empathise with the huge numbers of innocent people who have been affected.

The danger for the world is that the war could escalate and draw in other countries, leading to regional conflict, death and destruction. From an economic perspective, this would likely cause higher energy prices, inflation, and slower world growth, as in the mid-1970s. Should investors be preparing for this?

We have no special insight into how the crisis will turn out. Instead, at times like these, we focus on the more general question: What normally happens to markets after geopolitical crises? Let’s look at three main issues: escalation, uncertainty, and the long term.

First, usually it’s not the geopolitical event but the escalation afterwards that leads to disaster. For example, the assassination of Archduke Franz Ferdinand on 28 June 1914 was an extreme provocation by the Bosnian Serb Gavrilo Princip. But it took bad diplomacy, bruised egos and incompetence to spark off the First World War an entire month later. Hundreds of leaders have been assassinated across the world in the last two centuries, and most assassinations did not lead to wars or massacres.

Israel’s response to Gaza has been limited thus far, and we are hopeful that this will continue, with American encouragement. The financial markets seem to expect this, to judge by their relative calmness in the last two weeks. Israeli politics and the desire for revenge, though, may make it unlikely.

Second, geopolitical events are generally associated with heightened uncertainty and fear in the markets. The conventional playbook for a Middle Eastern crisis is that equities plunge as investors flee risk, government bonds rise as investors rush to safety, and commodity prices soar, led by oil, due to supply falling.

Our portfolios are positioned defensively right now, with a moderate equity and credit underweight, an overweight to safe-haven government bonds, some exposure to oil producers, and a fair allocation to protective trading strategies like trend-following. We think they’ll perform well if the crisis escalates.

Third, geopolitical crises dissipate eventually, and life returns mostly to normal. WW1 came to an end, post-war reconstruction was smooth, and much of the world economy had recovered by the early 1920s. Financial markets cope with geopolitical crises well, and it’s usually best for investors not to overreact.

In short, we believe 7IM portfolios are not especially vulnerable to the crisis, and will look for opportunities if markets overreact to events.