Navigating higher energy prices

The outbreak of a wider war in the Middle East has reawakened fears of inflation, as energy prices have rocketed.

This is a classic example of unpredictable and impactful events that continue to occur. In the short time since the start of the Iran war, equity and bonds have sold off while the US dollar and share prices rose for oil and gas companies.

What happens during and beyond a conditional two-week ceasefire is not known. There are many feasible scenarios, each with quite different economic and market impacts.

Investors continue to face the question of how to respond. Our approach is to review the readiness of our portfolios for what may come, knowing that there is huge uncertainty. As we do this, we are looking at what markets have already priced in and the likelihood of extreme scenarios.

In a nutshell, energy prices, inflation expectations and bond prices now reflect ongoing higher oil and petrol prices and no further cut in interest rates by the South African Reserve Bank (SARB). Markets have now priced in rate hikes towards the end of this year, given the impact on oil and a weaker rand, which will likely lead to higher inflation in the short to medium term.

Thankfully, historic energy crises are not a reliable guide to the more probable future scenarios.

Firstly, the world is a lot less sensitive to moves in oil and gas prices. The Shale revolution has transformed the world’s largest economy, the United States, from an energy importer to an exporter. Plus, renewable energy meets far more of our energy needs, in terms of electricity generation and transport. It’s especially important for China, the world’s second biggest economy. Technological advances mean economies are more energy efficient, with the notable exception of power-hungry Artificial Intelligence.

Secondly, inflation is much better anchored. Global prices are being kept in check by overproduction and exports by China, the disinflationary impact of AI, the reduced power of unions globally and renewed vigilance by central banks.

Thirdly, interest rates are at more sustainable levels than prior energy shocks, limiting the need for large rate rises to quash inflationary pressures.

So, we do not see a return to 1970s stagflation. There is potential for this crisis to create shocks that are more inflationary than deflationary. For this, we hold a range of diversifiers in our Global solutions, such as defensive industries less impacted by business cycles, inflation-linked bonds and liquid alternative investment strategies.

The crisis, like all prior ones, will also create new opportunities. We are closely tracking how events are impacting businesses and asset prices to identify risks and spot opportunities, working closely with Morningstar’s 900-strong research team. As investors, however, our minds remain on what we believe is most important when investing—namely, leveraging our deep, global research and data to balance risk and reward - and coaching ourselves and others to make good decisions.