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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is senior adviser at Engine AI and former chief global equity strategist at Citigroup
Like many, I am depressed by the direction the world seems to be taking. Events in the Middle East and Ukraine are especially worrying. But stock markets do not seem to care. Global equity indices have hit new highs. Geopolitical bears think this is unsustainable. I think they have missed the impact of US shale.
Whenever geopolitics heats up, the first place I look is the energy markets. Traditionally, oil prices go up a lot and stock markets go down a lot.
Back in the 1973-74 Middle East crisis, in association with an Opec embargo, oil rose 300 per cent. The S&P 500 index halved. Around the Gulf war of 1990, oil doubled while the S&P 500 fell almost 20 per cent.
Over time, the price moves have become less severe. In the quarter before the March 2003 invasion of Iraq, oil rose 20 per cent, but soon gave back those gains. The S&P increased 7 per cent in the first half of 2003.
The 2022 invasion of Ukraine did feed into energy and equity markets. Liquid natural gas prices rose 300 per cent, but they are now back down at pre-invasion levels. The S&P 500 fell 18 per cent in 2022 but recovered quickly in 2023.
The latest turmoil in the Middle East has also had a muted effect on energy prices. It has had little impact on global stock markets. Quite the contrary — the S&P is 20 per cent higher than when this conflict started in October last year.
Why are energy and stock markets becoming less sensitive to geopolitical events, especially in the Middle East? I attribute much of this to US (and Canadian) shale.
New drilling techniques have opened up access to enormous oil and gas reserves in North America. As a result, in 2019 the US moved from being a net importer to an exporter of energy, according to the EIA.
This newfound self-sufficiency has reduced the impact of external events on the world’s dominant stock market (US equities now represent 64 per cent of the MSCI AC World benchmark).
Even when geopolitical turmoil pushes up the oil price, a subsequent increase in US shale production helps drive it back down again. By capping the upside to energy prices, this helps limit the downside for equity prices. US shale has become a geopolitical put option for stock markets. Even in Europe, which is most exposed to the war in Ukraine, a shift towards renewable energy should reduce future vulnerability.
Of course, geopolitics is not just about energy prices. Increasing antagonism between the US and China is another source of current angst, most notably around the future of Taiwan.
This has taken some of the blame for the poor recent performance of the Chinese stock market. The MSCI China index is down more than 15 per cent in the past year.
But, even here, the story is inconsistent. Some big US stocks with significant business exposure to China or Taiwan, most notably Nvidia, have forged ahead.
As for the future, if semiconductors really are the new oil, maybe financial markets should start watching events in the South China Sea more closely than they do events in the Middle East.
As an equity strategist, I learnt to be aware of geopolitical risks, but not over-obsess. That is because they usually make me depressed, and hence too bearish on markets. After all, nobody sees geopolitics as a reason to be bullish. I do not mean to trivialise the humanitarian consequences of recent events across the world, but a professional lifetime advising investors has taught me that bad geopolitics do not always mean bad stock markets.
Nevertheless, when I ask investors to identify their biggest concern right now, many cite geopolitics. While entirely understandable, this feels a bit lazy.
I am not arguing in favour of ignorance. We all need to listen to geopolitical experts, and being better-informed is always a good thing. I also understand that, in 50 years, history books will be written about current events in the Middle East and Ukraine. Few will remember that the S&P has been hitting new highs.
However, to be good at their day jobs, professional investors need to understand how geopolitics feeds into markets. In the past, global turmoil meant big increases in oil prices and big decreases in equity prices.
Shale energy has profoundly changed this transmission mechanism. Investors considering how to respond to the latest escalation between Israel and Iran should bear this in mind.