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Roula Khalaf, editor-in-chief of the FT, selects her favorite stories in this weekly newsletter.
The author is a senior advisor at Engine AI and former chief global equity strategist at Citigroup.
Like many, I am depressed by the direction the world seems to be heading. Events in the Middle East and Ukraine are particularly worrying. But the stock markets don’t seem to care. Global stock indices have reached new highs. Geopolitical bears think this is unsustainable. I think they didn’t take into account the impact of American shale.
Whenever geopolitics heat up, the first place I look is the energy markets. Traditionally, oil prices go up a lot and stock markets go down a lot.
During the Middle East crisis of 1973-74, combined with an OPEC embargo, oil increased by 300 percent. The S&P 500 index has halved. Around the 1990 Gulf War, oil doubled while the S&P 500 fell nearly 20 percent.
Over time, price fluctuations became less severe. In the quarter before the invasion of Iraq in March 2003, oil rose 20 percent, but quickly gave back those gains. The S&P rose 7 percent in the first half of 2003.
The 2022 invasion of Ukraine has indeed reverberated through energy and stock markets. Liquid natural gas prices increased by 300 percent, but are now back to pre-invasion levels. The S&P 500 fell 18% in 2022 but quickly recovered in 2023.
The latest disruptions in the Middle East have also had a muted effect on energy prices. This had little impact on global stock markets. Quite the contrary: the S&P index is 20 percent higher than at the start of the conflict in October last year.
Why are energy and equity markets becoming less sensitive to geopolitical events, particularly in the Middle East? I attribute much of this to American (and Canadian) shales.
New drilling techniques have opened access to enormous oil and gas reserves in North America. As a result, in 2019, the United States moved from being a net importer to an exporter of energy, according to the EIA.
This newfound self-sufficiency has reduced the impact of external events on the world’s dominant stock market (US stocks now make up 64 percent of the MSCI AC World benchmark).
Even when geopolitical unrest pushes the price of oil up, a subsequent increase in U.S. shale production helps drive it down again. By limiting the rise in energy prices, this helps limit the decline in stock prices. US shale has become a geopolitical put option for stock markets. Even in Europe, which is most exposed to the war in Ukraine, a transition to renewable energy should reduce future vulnerability.
Of course, geopolitics is not just about energy prices. Growing antagonism between the United States and China is another source of current anxiety, particularly around the future of Taiwan.
This partly explains the recent poor performance of the Chinese stock market. The MSCI China index has fallen more than 15 percent over the past year.
But even here the story is inconsistent. Certain large American stocks heavily exposed to China or Taiwan, notably Nvidia, have progressed.
Looking ahead, if semiconductors truly are the new oil, perhaps financial markets should start monitoring events in the South China Sea more closely than they do in the Middle East.
As an equity strategist, I have learned to be aware of geopolitical risks, but without being overly obsessed. This is because they usually make me depressed, and therefore too bearish on the markets. After all, no one sees geopolitics as a reason to be optimistic. I do not intend to trivialize the humanitarian consequences of recent events around the world, but my professional life advising investors has taught me that bad geopolitics does not always mean bad stock markets.
Still, when I ask investors to identify their biggest concern right now, many cite geopolitics. While completely understandable, it seems a bit lazy.
I am not advocating ignorance. We all need to listen to geopolitical experts, and being better informed is always a good thing. I also understand that in 50 years history books will be written about current events in the Middle East and Ukraine. Few remember that the S&P hit new highs.
However, to succeed in their daily work, professional investors must understand how geopolitics fuels markets. In the past, global unrest has led to sharp increases in oil prices and sharp declines in stock prices.
Shale energy has profoundly modified this transmission mechanism. Investors considering how to respond to the latest escalation between Israel and Iran should keep this in mind.
