How this market wobble compares

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In both of my lines of work - investment and opinion - there is a premium on having a view. It is as if the worst possible thing we could say in any situation is ‘I don’t know’.

When it comes to column writing that makes some sense. In investment, it is less obviously beneficial. Not knowing, and accepting it, is a defining characteristic of being an investor. Having to make choices in the dark, with no line of sight, no crystal ball, is just how it is. You would have thought more of us would be happy to admit this.

Perhaps after the dust settles on the current Gulf conflict more of us will do so. I have been struck in my conversations over the past couple of weeks by the number of investors who have confessed to having no idea where all this is going.

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In large part, it is the Trump factor. The President has weaponised uncertainty. For him it is a negotiating strategy, which no doubt has a place in the cut and thrust of real estate deals. When you are the most powerful man on the planet, however, it is pretty destabilising.

No-one really knows how to assess the current crisis or what to compare it to. Yes, it’s a war. Investors have plenty of experience of navigating those. It is clearly about oil, too, and has an economic dimension. It’s a potential inflation shock. And, therefore, a policy challenge. But perhaps the best way to view it is as a crisis of uncertainty.

Ask anyone what they think will happen and they will say ‘it depends how long it goes on for’. Which is true but unhelpful. Because the answer to that probably depends on which side of bed the President gets out of. It is a shaky foundation on which to build an investment strategy.

At times like this, history can sometimes help. But looking back over recent decades, there isn’t really a good template. A few recent crises look sort of similar. But nothing is a particularly compelling analogy. It really is different every time.

The crisis I instinctively reach for when it comes to uncertainty is Covid. That was when investors really could be forgiven for not knowing how things would turn out. Then, as now, there was zero visibility about either the duration or the severity of the crisis. Forecasts were pointless.

But that is where the similarity may end. The sell-off in markets was abrupt, perhaps the fastest in market history. In light of the fact that entire industries ground to a complete standstill, that was probably appropriate. But negativity turned out to be the wrong strategy in 2020. As we now know it was a classic V-shaped market recovery. And it happened long before there was any clarity on the medical front.

The other crisis of existential uncertainty in recent years was the global financial crisis (GFC). There were days in 2008 when no-one could be sure that the world’s financial system would survive. Again, there was a lack of visibility - of earnings, credit-worthiness and policy effectiveness. As with Covid, the market response to the GFC was rapid and profound. In the first, share prices fell by a third in a matter of weeks; in the latter by a half in a few months. The initial error was being too optimistic, but again it paid to turn positive sooner rather than later.

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The crisis that looks most similar is the most recent one. The invasion of Ukraine in 2022 was similarly a war of choice, triggering an energy price spike and a subsequent inflation shock. I suspect one similarity between then and now will be a correlation in the price action of shares and bonds. The longer the Gulf crisis persists the more likely that equities and fixed income will fall in tandem.

But there are key differences too. The inflationary backdrop in 2022 was worse. We were just emerging from the pandemic, with a very tight labour market and severe supply chain disruptions across a range of industries. And the Russian energy crisis was less global than today’s. Russian gas pipelines are not the Strait of Hormuz.

I would be wary of drawing too many parallels with the energy crises of the 1970s either. Energy costs fed into inflation then, as they could still now, and policymakers face similar challenges in balancing the competing pressures of inflation and stagnation. But the world was a very different place - industry was more energy intensive, labour more powerful, central banks less credible.

It is hardly surprising that markets are struggling for direction. There have been too many occasions in the very recent past when a surfeit of caution has been costly. Covid, Ukraine, tariffs - they were all buying opportunities. It might feel like this is more serious, but in all three earlier cases it felt just as consequential at the time. Even if you couldn’t bring yourself to take advantage, doing nothing was a plausible strategy.

And so it is today - with two caveats. First, sitting on your hands only makes sense if you have taken the opportunity during the past three years of rising markets to put some defences around your investments. Diversification, by geography and by asset class, is the best protection against uncertainty.

Second, be alert to the possibility that this common or garden oil and inflation shock could yet turn into something more damagingly systemic. Three things I will be watching out for are: central banks tightening too fast in the face of weakening growth; credit markets starting to crack - defaults rising and corporate bond yields rising fast; the failure, out of the blue, of an obscure but leveraged hedge fund or trader - there is never one cockroach.

Most investors are still of the view that these scenarios are unlikely. Which is precisely the moment to be most watchful. The one thing I can say with complete confidence is that ‘I don’t know’. Whatever they might say, nor does anyone else.

This article was originally published in The Telegraph.

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