Oh! What a weird war for investors

 

Buying oil might be the right move now

Simon Edelsten

This article was originally published in the Financial Times

My lunch club came together about three years ago as City friends headed into various forms of retirement. It occurred to me that none of this lot were likely to lose their interest in investments and markets. All I had to do was to book a table at a London boozer and an entertaining, and maybe profitable, chat might evolve.

The group mostly started working in the early 1980s. We were trained by stockbrokers who had recently experienced the 1970s oil crisis and the years of stagflation that followed. All saw investments in energy stocks as being core to an equity portfolio aimed at coping with inflation. Are these lessons we can apply to the still volatile situation in Iran?

It’s worth thinking about the parallels and differences between then and now. In 1973, when Gulf states implemented their oil embargo, the impact was a fourfold increase in oil prices. The ensuing inflation shock crashed stock markets — US equities halved and the UK market FT30 index plunged by 73 per cent.

Fast forward to Putin’s invasion of Ukraine. Energy prices rose sharply in the aftermath, consumer staples and healthcare held their value. On the downside, consumer cyclicals and real estate struggled. Technology and financials weren’t great either.

At our most recent lunch club meeting, we speculated on what we would have done if we had known ahead of time that the US was about to bomb Iran. We’d have done three things:

• Bought oil
• Bought gold
• Bought defensive stocks.

The oil trade would have worked (but much less well than in previous shocks). The other two would have failed. Markets have not reacted to recent events in the classic style.

First, oil. Many economies are less reliant on crude oil than they were 60 years ago, and extra crude production can be brought online from fracking within weeks. However, buffer stocks are low and, as can already be seen in emerging markets, which import crude and its products, shortages and regional price surges are appearing in diesel, fertiliser and plastic feedstocks.

The most important investment objective for most of us is to keep pace with inflation. Energy shocks have frequently been the main — and most unpredictable — cause of inflation. Therefore, having a core allocation to energy stocks seems prudent in war and in peace. This allocation, once considered core, seems nowadays to be against consensus — which is where money is usually made.

Some of us remember oil shares making up 14 per cent of global equities in the early 2000s. In the current climate, 10 per cent in energy stocks might be deemed a good balance. For investors without any, the ceasefire may have brought an opportunity. Oil prices (Brent crude) above $80 are very profitable for most companies, which have had to cope with prices below $70 for the past few years.

We hold Exxon and EQT, the largest gas producer in the US. But energy stocks needn’t just mean oil, as I mentioned in January. I’ve recently reinvested in Ørsted, the world’s largest wind farm operator and owner of the huge Hornsea wind farms off the UK east coast. I owned Ørsted shares in the late 2010s and sold them not long before the peak in 2021.

Since then, the company has retrenched and refinanced, but it now looks financially secure. Much of its electricity is sold at prices which are fixed with an inflation link, so it benefits modestly from higher UK electricity prices.

Gold normally goes up when war breaks out, but it had already risen an awful lot before, so I’m more bemused than shocked by its recent fall in price.

The real puzzler has been the market’s reaction to “defensive” sectors — and here may lie another small window of investment opportunity. Normally, equity investors expect war to raise inflation and reduce growth, so they sell economically sensitive sectors, such as banks and housebuilders, and buy sectors with stable demand, such as telecoms, healthcare and consumer staples.

Some defensive sectors, especially those with low growth, are seen as “bond proxies”. Bonds have fallen as investors expect inflation to return (as it did early in the Ukraine war) and central banks to respond with higher interest rates, whereas previously investors had expected rates to fall. This is very reminiscent of the stagflation of the 1970s and has hit real estate companies hard.

Technology stocks whose capital spending is roaring ahead — such as Microsoft, Alphabet and Meta — offered little shelter in March. Their shares dropped by 7.1 per cent, 7.7 per cent and 12.5 per cent respectively.

The usual safe haven consumer staples and healthcare stocks have also suffered. Maybe they were seen as expensive going into this war. I would normally have expected a company like Procter & Gamble (maker of Gillette razors, Ariel soap powder, etc.) to hold up well, but its shares were down nearly 14 per cent in March. Similarly, Stryker, the world leader in medical equipment and orthopaedics — another defensive sector — has seen its shares fall more than 12 per cent. If markets moved the way they did on the Ukraine invasion, these would be going up. We own neither share, but both seem worth assessing if the Gulf problems endure.

And history suggests they might rise, despite this week’s ceasefire. From the Great War of 1914-18 (“it will be over by Christmas”) to the Ukraine war (which Putin thought would last three days), we have a habit of underestimating how long these conflicts will go on. So, even as the conflict pauses, you should brace yourselves, and your portfolios.

My lunch club mates and I would have been wrong to buy defensive stocks a month ago. I suspect energy and defensives are worth a look now.

 

This research material is for distribution only to Professional and eligible counterparties as defined by the FCA and also to persons of a kind to whom it may lawfully be promoted by an authorised person by virtue of Section 238(5) of the Financial Services and Markets Act 2000, the Financial Services and Markets Act 2000 (Exemption) Order 2001 and COBS 4.12.4R. and should not be relied upon by any other persons. Therefore circulation of this research material must be restricted accordingly.

This material is provided for information purposes only and does not constitute a solicitation in any jurisdiction in which such solicitation is unlawful or to any person to whom it is unlawful. Moreover, it neither constitutes an offer to enter into an investment agreement with the recipient of this document nor an invitation to respond to it by making an offer to enter into an investment agreement. This research material may contain forward-looking information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition.

Moreover, certain historical performance information, other investment vehicles or composite accounts included in this material and such performance information is presented by way of example only. No representation is made that the performance presented will be achieved, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the time of publication and may change as subsequent conditions vary. The information and opinions contained in this research material are derived from non-proprietary sources deemed by the Firm to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not indicative of future results. The value of your investment may go down as well as up, and you may not receive upon redemption the full amount of your original investment.

The Investment Manager is authorised and regulated by the Financial Conduct Authority and registered in England and Wales (Company Number: OC304213). Its registered office address is 6 Stratton Street, Mayfair, London W1J 8LD United Kingdom.