Oil reflects the ebb and flow of Gulf tensions

The quiet days of summer are with us, but there’s still plenty on the radar to keep investors busy.

Easing tensions

The oil price remains the main transmission mechanism for tensions in the Gulf to feed into financial markets. Oil fell 7% as the week got under way after a quiet weekend in which the US and Iran both refrained from attacking each other.

With petrol prices above $4 a gallon, and mid-term elections looming, we should expect domestic politics to wield an increasingly important influence over America’s foreign policy. With just 36% of Americans approving of the job the President’s doing, de-escalation could be the watchword for the next 100 days.

Oil may have fallen to $90 a barrel but with the Strait of Hormuz still largely closed, and the recent ceasefire too short to allow much rebuilding of reserves around the world, further falls in the price of crude may be too much to hope for.

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Rate hikes in focus

That’s the unhelpful backdrop to this week’s flurry of interest rate decisions in the US, UK and Japan.

In the US, it’s new Fed chair Kevin Warsh’s second meeting in charge. And the pressure is mounting for him to deliver the first rate-hike of his tenure. A strong US economy and labour market mean last week’s lower inflation reading of 3.5% was almost certainly a ceasefire-fuelled one-off. The rate is anyway well ahead of the Fed’s 2% target.

So, even if there is no move this week (and the oil price reduced the odds of a hike this week from 36% to 30%), there very likely will be one in September. And one or two more before the middle of next year.

Over here, the Bank of England surely won’t raise rates just a week after a new Prime Minister entered Downing Street. Thereafter, the outlook is less certain, however, with inflation here too likely to rise from last week’s unexpectedly low 2.6%.

In Japan it’s a different story. After years of deflation, energy price hikes have actually played into a positive reflation story. Normalisation of rates continues, albeit to a Japanese normal of perhaps 1.25% by year end.

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Earnings remain supportive

The other big focus this week will be the continuation of the second quarter earnings season, which kicked off a couple of weeks ago.

There will be more tech stocks updating investors on AI spending plans, some airlines (fretting about higher fuel costs) and UK banks (looking nervously at new PM Andy Burnham’s tax plans).

Corporate earnings continue to provide a supportive underpinning to the ongoing but fragile bull market. Expectations were strong at the start of earnings season, and they have nudged higher as results have emerged. Another quarter of 20%+ growth looks to be on the cards.

That’s good news for investors because, as a matter of simple arithmetic, higher earnings mean lower valuations. Shares are not cheap in the US, but they are also not at the excessive levels that typically bring a bull market to an abrupt end.

The broadening bull market

The average valuation is also easing thanks to the relative underperformance of the highly rated tech companies that have driven shares higher in recent years. The Mag Seven has gone sideways since the end of last year as investors have questioned whether the so-called hyperscalers will ever earn an acceptable return on their massive investment in AI infrastructure.

In the past three months, the equal weighted S&P 500 index has outperformed the capitalisation weighted headline index as investors have rotated into the shares which have lagged the leaders for many years.

Since the recent peak at the start of June, the S&P 500 index is down just over 2% while the equal weighted version is up 2%. The Mag Seven has fallen by 9% while non-AI-related shares are up by 5%.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.