Stock tickers may not immediately price in uncertainty during
times of geopolitical volatility. Our Head of Corporate Credit
Research Andrew Sheets suggests a different indicator to watch.
Read more insights from Morgan Stanley.
----- Transcript -----
Andrew Sheets: Welcome to Thoughts on the
Market. I'm Andrew Sheets, Head of Corporate Credit Research at
Morgan Stanley.
Today I'm going to talk about how we're trying to simplify the
complicated questions of recent geopolitical events.
It's Friday, June 27th at 2pm in London.
Recent U.S. airstrikes against Iran and the ongoing conflict
between Iran and Israel have dominated the headlines. The
situation is complicated, uncertain, and ever changing. From the
time that this episode is recorded to when you listen to it,
conditions may very well have changed again.
Geopolitical events such as this one often have a serious human,
social and financial cost, but they do not consistently have an
impact on markets. As analysis by my colleague, Michael Wilson
and his team have shown, over a number of key geopolitical events
over the last 30 years, the impact on the S&P 500 has often
been either fleeting or somewhat non-existent. Other factors, in
short, dominate markets.
So how to deal with this conundrum? How to take current events
seriously while respecting that historical precedent that they
often can have more limited market impact? How to make a forecast
when quite simply few investors feel like they have an edge in
predicting where these events will go next?
In our view, the best way to simplify the market's response is to
watch oil prices. Oil remains an important input to the world
economy, where changes in price are felt quickly by businesses
and consumers.
So when we look back at past geopolitical events that did move
markets in a more sustained way, a large increase in oil prices
often meaning a rise of more than 75 percent year-over-year was
often part of the story. Such a rise in such an important
economic input in such a short period of time increases the risk
of recession; something that credit markets and many other
markets need to care about. So how can we apply this today?
Well, for all the seriousness and severity of the current
conflict, oil prices are actually down about 20 percent relative
to a year ago. This simply puts current conditions in a very
different category than those other periods be they the 1970s or
more recently, Russia's invasion of Ukraine that represented
genuine oil price shocks. Why is oil down? Well, as my colleague
Martin Rats referred to on an earlier episode of this program,
oil markets do have very healthy levels of supply, which is
helping to cushion these shocks.
With oil prices actually lower than a year ago, we think the
credit will focus on other things. To the positive, we see an
alignment of a few short-term positive factors, specifically a
pretty good balance of supply and demand in the credit market,
low realized volatility, and a historically good window in the
very near term for performance. Indeed, over the last 15 years,
July has represented the best month of the year for returns in
both investment grade and high yield credit in both the U.S. and
in Europe.
And what could disrupt this? Well, a significant spike in oil
prices could be one culprit, but we think a more likely catalyst
is a shift of those favorable conditions, which could happen from
August and beyond. From here, Morgan Stanley economists’
forecasts see a worsening mix of growth in inflation in the U.S.,
while seasonal return patterns to flip from good to bad.
In the meantime, however, we will keep watching oil.
Thank you as always for your time. If you find Thoughts the
Market useful, let us know by leaving a review wherever you
listen, and also tell a friend or colleague about us today.
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