Written by:
Alex Chappell
Investment Manager at Amber River DB Wood
At some stage in the future, we will be able to start this blog without focusing on the conflict in Iran. Hopefully that’s not too far away, but for now it remains the main factor that is influencing markets.
The latest position is a bit like a Mexican standoff, with a ceasefire in place but both the Strait of Hormuz and any Iranian ports, blocked. Who is going to blink first, either to come to the negotiating table or to escalate?
Despite that backdrop, April has been a very good month for returns. In our lower risk portfolios we end the month with overall income yields back to levels of October 2023, so lots of future income to look forward to, especially if inflation remains reasonably contained. Equities seem to be looking through the war, and have performed well, helping our higher risk portfolios to a larger degree. At the same time they also have more exposure to an escalation or elongation of the current position. The portfolio range has added between 0.97% (Very Low Risk) and 7.31% (High), which do not sound like the sort of returns that should have been delivered given the backdrop, but there have been a few factors here worth noting.
The first is that the end of March was the low point for markets this year. At the time the conflict was spiralling, with attacks on energy infrastructure across the Middle East, and there was a very real possibility of disruption to energy markets beyond the level we currently have. These risks have not gone away as we move into May, and this last week has seen an increase in negative volatility given the lack of progress towards any form of meaningful negotiation.
The other key factor which has supported markets in recent weeks is a raft of positive earnings releases out of the US, where expectations across the board have been beaten. This is, of course, in some way old news, as these were earnings delivered before the conflict broke out. Either way, they have gone some way to show that excluding Iran, things were looking more positive than investors had perhaps given credit for.
Iran has a matter of weeks not months of supply to support its production of oil
In contrast to equity markets, bond markets have remained a lot more cynical. They have not yet priced in an end to the conflict and continue to reflect the risk of higher inflation in the UK this year. Oil is the main driver of this inflationary pressure, and as we talk it is trading at c$110 per barrel, up from $60 prior to the conflict starting. Petrol prices have moved from the mid £1.30s to the mid £1.50s per litre, so around a 15% increase so far, and they are likely to creep higher still the longer this goes on.
The big question remains how long this will go on for? A short resolution (next 3-4 weeks) will likely be enough to avoid a significant uptick to inflation and worse, long lasting economic damage from a high oil price. Progress into mid-summer without a resolution will almost certainly start to get into the territory where equity markets can no longer look through things and think that no economic pain will be felt. We see this as an unlikely tailwind, just simply because of the humanitarian effects on the Iranian people (from food shortages for example), but also because Iran’s oil refineries will suffer significant damage if they are out of production. Iran has a matter of weeks not months of supply to support its production of oil.
May is therefore a big month, and as if that were not enough to occupy us, we have local elections in the UK on 7th May, where we are expecting the Labour party to be significantly damaged. We think the damage to Starmer is already priced into markets, though what is unknown is the effect of a more left wing challenge to Rachel Reeves, which would leave markets exposed to a further widening of the UK’s fiscal deficit. So plenty to get stuck into, before we can see a clear path forward.
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