Weekly Investment Update (10/13/2023)

This Week’s Views and Positioning

Even prior to the horrific terrorist attacks in Israel, investors were focused on the potential implications of higher oil prices. Although currently up only 3% year-to-date, WTI crude oil was up over 15% a few months ago. 

Geopolitically driven oil shocks in the 1970s and 1990s were enough to tip already vulnerable economies into recession. Naturally, investors begin to make parallels when assessing the current situation. For now, however, oil markets appear to be taking a “wait and see” approach as oil prices remain well below year-to-date highs. Critical questions remain unanswered: To what extent might the war escalate? Will the U.S.  increasingly enforce Iranian oil sanctions? Will Saudi Arabia increase production? How much capacity does the U.S. have to offset any lost production from Iranian exports? How will the global demand picture evolve as economies continue to absorb higher interest rates? Although recent events likely place a higher floor under oil prices, these questions (among many others) make a material oil spike far from a foregone conclusion.

Although a material increase in energy prices could alter inflation dynamics, recent commentary from Fed officials supports our view that their tightening cycle is likely complete. As we discuss below, the trend in core inflation is likely enough to enable the Fed to not hike interest rates in November, even if it remains too soon to expect any material monetary policy easing. Please see our latest Quarterly Investment Perspective for Bessemer’s comprehensive views.

Terrorist Attacks Against Israel Keep Geopolitics in Focus

What is happening: In the early hours of Saturday, October 7, the terrorist organization Hamas launched a surprise attack by land, sea, and air across central and southern Israel. The attack, which was the largest terrorist operation against Israel in decades, resulted in hundreds killed or injured, others taken hostage, and other senseless acts. Israel’s leader, Benjamin Netanyahu, subsequently declared that the country is “at war” and in an unprecedented move has drafted in more than 360,000 reservists. The Israeli military has swiftly responded to the terrorist attacks by striking over 2,600 “Hamas targets” in Gaza. Other countries that have quickly joined the U.S. in support of Israel include Germany, the U.K., France, and Italy, which together made a joint statement of “steadfast and united support to the state of Israel.”

Why it matters: Our first thoughts are for the loss of lives and the families of innocent civilians affected by the attacks on Israel. The events are a tragedy on a human level. At this time, it seems possible the war will remain localized with diplomatic efforts focusing on containing the conflict. If this is the case, the impact on global economies and markets should be minimal.

Over the past 40 years, conflicts in the Middle East involving minor oil producing nations have had limited impact on wider financial markets; usually, the medium to long-term effect on equity and bond markets tends to be muted despite initial volatility. This dynamic was seen with the Russia/Ukraine war following the initial invasion. However, in that case, given the shock to commodity markets, notably grain and natural gas, the conflict contributed to widespread inflationary pressures, the secondary effects of which were felt across global financial markets. We do not expect a similar reaction in commodity markets here unless the conflict escalates across the wider region.

Still, energy markets remain a critical concern, and with more geopolitical uncertainty, oil prices could remain elevated in the near future. An oil supply shock, including an attack on Iranian oil assets or increased U.S. enforcement of Iranian sanctions, would likely increase volatility and place upward pressure on oil prices. Energy and defense stocks (Bessemer portfolios are overweight both) are likely to appreciate in a sustained or expanding conflict. Treasuries, where Bessemer has a longer-than-benchmark duration position, would also likely rally as investors turn to safe-haven assets.

Inflation Slows, but Underlying Components Remain Sticky

What is happening: Headline CPI inflation came in above expectations for the month of September, rising 0.4% month-over-month compared to an expected 0.3% increase, keeping the year-over-year rate steady at 3.7%. Meanwhile, core CPI met expectations for a 0.3% monthly increase, which brought the year-over-year core rate down to 4.1% in September from 4.3% in August. Core CPI in September was primarily driven by continued gains in shelter prices, while higher gasoline prices drove the stronger-than-expected headline reading. Core services excluding housing, a key metric for the Federal Reserve given its correlation to the labor market, rose by 0.6%, representing the largest monthly gain in a year. Labor market tightness persists with initial jobless claims remaining at a low level of 209k.   

Why it matters: Earlier this week, Treasury yields and interest rate hike probabilities declined after multiple Federal Reserve officials noted that they will be cognizant of tightening financial conditions spurred by higher bond yields as they assess the future path of monetary policy. This more dovish language provided a boost to equity markets. However, following the CPI report, yields across the Treasury curve and expectations for an additional interest hike later this year rose modestly from 30% to 40%. While overall core inflation continued to ease, some of the underlying components remained stickier than expected, including core services excluding housing. We believe the Federal Reserve has concluded its interest rate hiking cycle, but it is likely to reiterate its higher-for-longer message given sticky inflation and tight labor markets.