Iran update: Straitjacket of Hormuz.
Iran update: Straitjacket of Hormuz.
While there are a significant number of risks associated with military conflict in the Persian Gulf region, the closure of the Strait of Hormuz has policymakers, economists, investors, and other observers very much on edge. Bracketed by Iran to the north and Oman to the south, the 24-mile-wide body of water is a key choke point for roughly a quarter of seaborne global crude oil and a fifth of liquefied natural gas (LNG), according to recent estimates from the International Energy Agency.1 The temporary loss of a fifth or more of global energy supplies, plus derived products, has suddenly raised the specter of stagflation, or low-to-negative growth combined with rising inflation – a hallmark of the oil embargoes of the 1970s.
While various technologies have shifted the energy-production mix in recent decades, oil is still characterized (correctly, in our view) as the lifeblood of the global economy. With that metaphor in mind, we can view the closure of the Strait as akin to an arterial blockage. Like healthy blood flow, the movements of oil and natural gas provide many downstream benefits beyond just basic energy, including distillates and other downstream products critical to many economic activities. A 20-25% blockage may not be life threatening to the global economy, but it is certainly going to cause some damage, and the extent of that damage will only increase the longer it remains closed.
Sharp spikes in energy prices are a well-known and closely studied risk factor for recessions and equity bear markets. A rough rule of thumb holds that a spike in spot crude oil prices above the highest level of the prior three years has typically preceded past recessions. We are at that point now. Higher energy prices also raise the risk of accelerating inflation, although those dynamics are more complicated to model and measure than data around employment and incomes, and are also subject to other important factors such as exchange-rate fluctuations. As concerning as the risks to growth and inflation have become, it’s important for investors to remember that market dynamics are still quite volatile and the geopolitical outlook highly uncertain, with far more unknowns than knowns. As a result, we can’t place explicit odds on any of the scenarios in front of us and would not counsel making significant, emotionally driven changes to strategic portfolios. We believe a well-designed, diversified portfolio should help investors weather multiple economic, inflation, and market regimes.
1 https://www.iea.org/about/oil-security-and-emergency-response/strait-of-hormuz
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