I signed off 2019 with the first half of this line from John Lennon’s Christmas song, Happy Xmas (War Is Over). When I was initially considering the title for 2020’s opener it seemed wholly inappropriate because it looked as though war was anything but over. Indeed a new one appeared to be kicking off in the Middle East. Yet here we are a week later with equity markets hovering around recent (and in some cases all-time) highs and safe haven assets in retreat. There are a number of things we need to discuss pertaining to this episode.
Conflict in the Middle East in the late 1970s, the early 1990s and the early 2000s remains closely associated with economic downturns.
First is the capacity of any event in the Middle East to rattle investors. Institutional memory is very deep, and it appears as though the scars of the early 1970s Oil Crisis have still not fully healed. Furthermore, conflict in the region in the late 1970s, the early 1990s and the early 2000s remains closely associated with economic downturns, although it’s far from clear that any of them were caused primarily by higher oil prices.
Respectively in those three cases: the Federal Reserve was already tightening the screws in the US; the US was suffering the fall-out from the Savings & Loans crisis and the UK was reversing a housing boom; we were in the full throes of the Tech Bust alongside the repercussions from 9/11. A spike in oil prices now would be more worrisome were other factors more negative, but central banks are currently in full-on easing mode and we continue to expect some of last year’s negative growth factors (such as global trade) to moderate.
The world’s economy is less oil-intensive than it used to be. Research from Deutsche Bank suggests that, almost fifty years on, we now consume two-thirds less oil per unit of economic output.
It’s also fair to say that Middle East oil resources are not as critical to the global economy as they were fifty years ago. There are larger sources of alternative supply, notably the United States and Russia, and even, at the margin, the North Sea (which didn’t really produce in great volumes until the mid-70s). Also, the world’s economy is less oil-intensive than it used to be. Research from Deutsche Bank suggests that, almost fifty years on, we now consume two-thirds less oil per unit of economic output - and of course the aim is to reduce this considerably further in light of the climate change threat.
We should also put the oil price move into perspective. In 1973/4 it quadrupled; in 1979 it doubled; in 1990 it rose two-and-a-half fold; from its 2002 trough to its 2003 peak it almost doubled. In response to President Trump’s New Year strike it went up a little more than 7%.
I am suspicious (although would admit that I have no hard evidence to present!) that a lot of the initial trade that takes place around incidents such as these is driven by computers looking at headlines and past price reactions to similar news – the infamous algorithms that we hear so much about, many of which are based on historical correlation models. It can take a little longer for calmer heads to prevail, especially in the initial absence of clarity. In this particular case we were faced with having to get inside Donald Trump’s head, which is something of a challenge at the best of times.
The evidence of the past week suggests no appetite for escalation on either side, which echoes previous incidents with North Korea. You might recall that markets had a now barely perceptible wobble in August 2017 when Kim Jong-un started testing nuclear-capable missiles, but we have learnt to live with the threat. We have been living with various levels of conflict between the US and Iran since the 1970s. “Middle East Conflict” is a permanent feature on lists of potential “icebergs” that could sink the global economy. But since the first Oil Crisis, it looks more as if a rising oil price has been the “final straw” rather than the primary cause - always good to get a camel reference into a piece on the Middle East!