Cohen & Steers is closely monitoring developments in the Middle East following the horrific terrorist attack on Israel. We offer a concise examination of the potential impact on real assets and the macroeconomic environment.
What happened?
The Hamas terrorist organization launched an unprecedented (land, sea and air) attack against Israel on October 7. Israeli forces have formally declared war on Hamas, launching an aggressive counter offensive and ordering a total siege of Gaza.
We are saddened and troubled by the violence and loss of life precipitated by the terrorist attack on Israel. The attacks are tragic and abhorrent. Terrorist attacks violate our most fundamental values and beliefs. Our thoughts are with those affected by these events.
The focus on markets (and real assets in particular) has been on the energy sector with a secondary focus on the macroeconomic environment. While oil fundamentals have remained unaffected at the moment, a war in the Middle East significantly increases the risk of supply disruptions in an already tight oil market. We believe there is a risk of further escalation beyond Israel’s borders, potentially involving the U.S., Iran and other regional powers. It is our opinion that these events will increase volatility and likely put a floor under energy commodity prices and energy company valuations.
Cohen & Steers is closely monitoring these developments, and we have positioned our strategies accordingly based on the real-time analysis of our investment professionals across the globe.
We are saddened and troubled by the violence and loss of life precipitated by the terrorist attack on Israel.
Significance for commodities
We expect the oil market to start to price increased geopolitical risk as uncertainty affects what was already a tight supply and demand market. At the same time, there are several specific developments that may follow, including:
- We believe it will be difficult for the Biden administration to maintain a soft stance on Iran oil sanctions. Therefore, lower Iran production/exports is a probable near-term outcome.
- There has been speculation in recent weeks of a potential U.S.–Saudi deal that could trigger a tapering of Saudi’s 1 million barrels per day unilateral production cut. This was contingent on the normalization of Saudi–Israel relations, which we believe will be put on hold given recent events.
- If the conflict escalates into a larger war between Israel and Iran, the Strait of Hormuz, a key artery of petroleum and liquefied natural gas (LNG) trade, could be at risk. Approximately 20% of the global petroleum liquids consumed and 20% of LNG exports are transported through the Strait. Other outlets for Persian Gulf energy exports are very limited.
Macroeconomic perspective
- A heightened geopolitical risk premium in energy markets may provide a floor to oil prices, which would filter into headline inflation and corporate input price pressure.
- Headline inflation is already above central bank inflation targets in most developed markets; any upward pressure from supply-side or geopolitical impacts will make inflation stabilization at 2.0%—which was already going to be very difficult to achieve—even more challenging. Consequently, interest rates may remain “higher for longer.”
- The U.S. dollar and other “safe-haven” currencies may see “flight-to-safety” investor flows amid heightened uncertainty.
- Politically, any further U.S.–Iran progress toward a nuclear deal (JCPOA) is very likely off the table, and a revival of support for additional defense/ munitions spending or border security may reassert itself.
Impact on real assets
We believe markets will start to price in increased geopolitical risk into oil prices as uncertainty adds to what was already a tight market. At the same time, there are several specific developments that further add to pricing pressure, including:
- Commodities
- Petroleum: The war complicates what is an already tight market for oil. The recent events could put a floor on oil prices with significant risk to the upside should the conflict escalate beyond Israel’s border.
- Natural gas: U.S. natural gas has shown little reaction to developments in Israel. However, Israel asked Chevron to halt operations at the Tamar gas field (off the Israeli coast) for safety reasons. This development has contributed to a spike in European LNG (TTF) and U.K. natural gas futures.
- Precious metals: Elevated geopolitical risks typically result in a flight to safety. We have seen this occur over the last few trading days. However, the war raises the prospect of higher oil prices, which could add to inflation risks.
- Natural resource equities: Modest impact. Energy companies have generally rallied since news of the initial attack broke, given the risk premia lift in energy broadly and what appears to be an influx of inflows into energy exchange-traded funds (ETFs).
- Global listed infrastructure: No significant impact. There are no Israeli- domiciled companies in the FTSE Global Core Infrastructure benchmark.
- Global real estate: No direct impact. Israel is 0.3% of the FTSE EPRA Nareit Developed Real Estate Index.
FURTHER READING
3 Reasons to own real assets
A diversified blend of real assets can potentially play a vital role in the new regime of higher inflation, higher rates and increased market volatility.
Secular drivers of inflation
Recent data indicates a slowing inflation trend, yet risks persist. Secular forces suggest that a prolonged elevated inflation period is underway with the potential for periodic price spikes. Factors driving long-term inflation include commodity underinvestment, tight labor markets, geopolitics, deglobalization and fiscal uncertainty. We see parallels to past inflationary eras, which highlight the difficulty of controlling inflation. While not predicting a return to 9%, the expectation is for a decade of higher-than-accustomed inflation, underscoring the importance of having a real assets allocation.
Opportunities in the era of scarcity
The world is transitioning from an era of commodity abundance to one of undersupply. We believe this shift may result in significant returns for commodities and resource producers over the next decade.
Index definitions and important disclosures
An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. Index comparisons have limitations as volatility and other characteristics may differ from a particular investment.
Data quoted represents past performance, which is no guarantee of future results. There is no guarantee that any historical trend illustrated/referenced above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. There is no guarantee that any market forecast set forth in this commentary will be realized. The views and opinions in the preceding commentary are as of the date of publication and are subject to change.
This material represents an assessment of the market environment at a specific point in time and should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment. This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or take into account the specific objectives or circumstances of any investor. We consider the information in this presentation to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing. The views and opinions expressed are not necessarily those of any broker/dealer or its affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules or guidelines.
The Bloomberg Commodity Total Return Index is a broadly diversified index that tracks the commodity markets through exchange-traded futures on physical commodities, which are weighted to account for economic significance and market liquidity. The FTSE EPRA/NAREIT Developed Real Estate Index is an unmanaged market-weighted total return index which consists of many companies from developed markets who derive more than half of their revenue from property-related activities. The FTSE Global Core Infrastructure 50/50 Index is a market-capitalization-weighted index of infrastructure-related securities in both developed and emerging markets; constituent weights are adjusted semiannually according to three broad industry sectors: 50% utilities, 30% transportation, and a 20% mix of other sectors, including pipelines, satellites and telecommunication towers.
Risks of investing in real estate securities: The risks of investing in real estate securities are similar to those associated with direct investments in real estate, including falling property values due to increasing vacancies or declining rents resulting from economic, legal, political or technological developments, lack of liquidity, limited diversification and sensitivity to certain economic factors such as interest rate changes and market recessions.
Risks of investing in global infrastructure securities: Investments in global infrastructure securities will likely be more susceptible to adverse economic or regulatory occurrences affecting global infrastructure companies than an investment that is not primarily invested in global infrastructure companies. Infrastructure issuers may be subject to regulation by various governmental authorities and may also be affected by governmental regulation of rates charged to customers, operational or other mishaps, tariffs, and changes in tax laws, regulatory policies, and accounting standards.
Risks of investing in foreign securities: Foreign securities involve special risks, including currency fluctuations, lower liquidity, political and economic uncertainties and differences in accounting standards. Some international securities may represent small- and medium-sized companies, which may be more susceptible to price volatility and less liquidity than larger companies.
Risks of investing in MLP securities: An investment in MLPs involves risks that differ from a similar investment in equity securities, such as common stock, of a corporation. Holders of equity securities issued by MLPs have the rights typically afforded to limited partners in a limited partnership. As compared to common shareholders of a corporation, holders of such equity securities have more limited control and limited rights to vote on matters affecting the partnership. There are certain tax risks associated with an investment in equity MLP units. Additionally, conflicts of interest may exist among common unit holders, subordinated unit holders and the general partner or managing member of an MLP; for example a conflict may arise as a result of incentive distribution payments.
Risks of investing in commodities: An investment in commodity-linked derivative instruments may be subject to greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. The use of derivatives presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. Among the risks presented are market risk, credit risk, counterparty risk, leverage risk and liquidity risk. The use of derivatives can lead to losses because of adverse movements in the price or value of the underlying asset, index or rate, which may be magnified by certain features of the derivatives.
Futures trading is volatile, highly leveraged and may be illiquid. Investments in commodity futures contracts and options on commodity futures contracts have a high degree of price variability and are subject to rapid and substantial price changes. Such investments could incur significant losses. There can be no assurance that the options strategy will be successful. The use of options on commodity futures contracts is to enhance risk-adjusted total returns. The use of options, however, may not provide any, or only partial, protection for market declines. The return performance of the commodity futures contracts may not parallel the performance of the commodities or indexes that serve as the basis for the options it buys or sells; this basis risk may reduce overall returns.
Risks of investing in natural resource equities: The market value of securities of natural resource companies may be affected by numerous factors, including events occurring in nature, inflationary pressures and international politics.
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