Are investors hallucinating?
I was fascinated by this morning’s Australian Financial Review (AFR) article, which pointed out markets appear to be disconnected from reality in the Middle East.
Comparing the current and more disruptive war in the Middle East to Russia’s invasion of Ukraine in 2022, which was far less disruptive to energy markets, the author notes:
“Back in 2022, Brent crude peaked at $US139 a barrel, compared with $US102 now. Back then, European gas peaked at €339 a megawatt hour, compared with €51 now. Back then, the price of urea, an oil by-product vital in the production of fertilisers, peaked at $US910 a tonne, compared with $US660 now. Back then, the S&P 500 fell 25 per cent peak-to-trough. Today, the index is down just 5.5 per cent from its January record high.”
There is some merit to the idea that markets are experiencing Geopolitical Complacency. The closure of the Strait of Hormuz is sending physical energy, fertiliser, food, transport and plastic markets into turmoil, but financial markets remain oddly buoyant.
It could perhaps be explained by the fact that investors see a few ships trickling through the Strait, the declining number of Iranian attacks on neighbouring countries’ energy and power infrastructure and published conditions for a ceasefire, as a justifiable reason to ‘look through’ the conflict. But buoyancy is still akin to putting it ‘all on black’.
Some economists – let’s call them the geopolitical realists – argue that investors are fundamentally underestimating the duration and structural disruption of this crisis as well as the scale of the shock to come.
Executive Director of the IEA, Fatih Birol, has been everywhere in the media describing the current situation as the “largest supply disruption in the history of the global oil market.” He argues the market is treating this as a temporary “spike” (similar to 2022), when in reality, the physical destruction of infrastructure – such as the strikes on Qatar’s Ras Laffan and Iran’s South Pars – has created a structural deficit that cannot be immediately fixed by a simple ceasefire.
Meanwhile, BCA Research’s, Juan Correa is warning of a “25 to 30 per cent drawdown” in the S&P 500. He argues markets are suffering from a “failure of imagination,” focusing on the possibility of peace talks while ignoring the reality that 20 per cent of the world’s oil and 21 per cent of its LNG have been “stranded” behind a blockade for an extended period.
The ‘air pockets’ feeding through the hose of the global supply chain will take some time to pass through and when they emerge, will produce surprises for investors.
Elsewhere, ANZ Bank’s economics team recently noted markets are “under-pricing the likely duration of the disruption.” They argue that, unlike 2022, when Russian oil eventually found its way to India and China, the Hormuz blockade is a “maritime paralysis” that leaves no alternative routes for the majority of Gulf exports.
And while all the attention is on oil, urea is a pivot point for many who see contagion beyond just fuel prices.
The Guardian’s Australian economics editor, Patrick Commins, points out that roughly one-third of the world’s urea and ammonia (essential for fertiliser) transits the Strait of Hormuz.
Think about this, the process of manufacturing urea and fertilisers takes time, and oil is the raw initial ingredient. That means the ‘hose’ through which fertiliser emerges is still mostly full. But at the other end, an air pocket has entered, potentially causing a global food security crisis by late 2026 as the next crop planting season in Asia and South America produces lower yields due to a lack of affordable nutrients.
Elsewhere, in the shipping industry, fuel costs are rising while shipping capacity is simultaneously falling. The break in the supply chain is more than just a price increase and is expected to lead to shortages of refined products like plastics and pharmaceuticals, the impact of which is not being priced in.
While many suggest the optimism in markets is therefore misplaced, there are several reasons for it.
Some commentators suggest markets are being driven by high-frequency trading (HFT) algorithms that scan for and react to headlines containing keywords such as “peace talks” or “deal,” or to Trump’s always-positive Truth Social posts.
The same commentators believe investors are so desperate for a “soft landing” that they are choosing to believe the headlines over the physical satellite data showing the Strait is still empty.
Investors are also betting on the normalisation of oil prices but it’s worth remembering the Russian invasion of Ukraine saw a re-routing supply. Today’s conflict has resulted in the elimination of supply.
It seems the hope of an end to the conflict is driving markets despite that end being unlikely to restore the consequent shortages of oil and downstream products. The damage to infrastructure and the depletion of Strategic Petroleum Reserves (SPR) mean high prices are more likely here to stay. So investors are arguably misguided in their hope that if a deal is reached, central banks will immediately return to a dovish stance.
If there’s going to be a tipping point, it will arrive when investors can no longer ignore the physical absence of fuel, fertiliser, and trade.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
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