Rising geo-political tensions are increasingly on investors and fund managers’ minds due to the recent escalation in the Middle East, as Western forces hover on the edge of military action against ISIS in Iraq and Syria.Tension between Ukraine and Russia has also continued in to rise in recent weeks and - like Iraq - both countries are important energy market players.
The Ukraine/Russia conflict is priced into markets and unlikely to escalate further, according to Richards, but the risk posed by a disruption to the oil-rich Middle East region is not.
“One of the risks that is not been taken on-board by markets is around oil and energy prices,” she said.
“People are using the argument that the US is effectively energy self-sufficient because of fracking, so we don't have to worry about oil prices because it will have less of a direct effect on the US economy.”
Over the past few months commodity prices have actually fallen while US equities have remained relatively stable.
Performance of indices over 3 months
Source: FE Analytics
Richards says in the short term the threat is less obvious due to lower seasonal demand for energy in during the summer months – but warns it could become more apparent later in 2014.
“When you put together the Ukrainian situation with gas and the tension in the Middle East with oil, being summertime we are less at risk because we're not so gas or oil intensive,” she explained.
“The first impact of all of the above could be a high and unexpected hike in energy costs as we go into winter and if we have a tough winter it will be doubly so. I think there might be some tension around that.”
Recently an improvement in the oil supply from Libya has actually contributed to a fall in the oil price, according to Caroline Bain, senior commodities economist at Capital Economics.
“Oil prices fell in July due to a deal between the Libyan government and rebels in the east of the country. This was mainly due to an increase in supply from Libya which overshadowed continued fighting in Iraq and an escalation in tensions in Ukraine,” she said.
“Libyan output has been dramatically reduced since the middle of last year due to a series of strikes by oil workers and disruption to oil facilities by rebels. ”
“However, in recent months a number of oil fields and ports have reopened, allowing output to rise slightly. This has increased hopes that Libya can begin exporting significant amounts of crude again, once the facilities are up and running.”
“A relatively cool summer has depressed demand for natural gas for power generation in the US. This has allowed record amounts of gas to flow into storage, which was heavily depleted during the winter.”
“Indeed, the combination of weak demand and abundant production has pulled down US gas prices to below $4 per MBTU again.”
However, the Russia/Ukraine crisis and various conflicts across the Middle East have escalated quickly in recent months and been increasingly worrying to financial markets getting used to low volatility.
Several analysts have said geo-politics is currently on the biggest threats to equity markets, evident in the sharp losses in the stock markets connected to the crises.
For example, our data shows that the MSCI Russia index is down 15.75 per cent this year while crude has risen by almost 3 per cent and gold has shot up 7.53 per cent.
Performance of indices in 2014
Source: FE Analytics
Despite the downward trend for Russian equities as sanctions continue to hit the investment outlook for the asset class, Richards says it has a greater chance of dissolving and therefore less of a risk to markets.
“There are clearly very intense discussions going on behind the scenes. It is an uncomfortable situation to have something that is perilously close to war, perilously close to the heart of Europe.”
“The sanctions that have been announced so far on Russia will hurt but over a period of time, they are not ceasing trading today, but there will clearly be an escalation of those sanctions if progress is not made on some of the negotiations.”
“But, sanctions hurt both sides so I don't think anyone believes anyone wants a full blown escalation of the Ukraine escalation - so my gut feeling is perhaps more sanctions but that we will eventually step back from the brink.”
