How are investors responding to the Iran conflict? with Victoria Scholar from interactive investor

Paul Diggle

Hello, and welcome to Macro Bytes, the economics and politics podcast from Aberdeen. My name is Paul Diggle.

Luke Bartholomew

And I'm Luke Bartholomew.

Paul Diggle

And today we are joined by Victoria Scholar, Head of Investment at Interactive Investor, the online investment platform, which I should, of course, mention is part of the wider Aberdeen group. And Victoria is joining us today, Tuesday, the 31st of March, to timestamp our conversation, to discuss the market and investor reaction to the ongoing conflict in the Middle East, the energy price shock, the substantial amount of geopolitical uncertainty that investors are having to navigate. So welcome, Victoria.

Victoria Scholar

Thanks so much for having me. It's great to be here.

Paul Diggle

So it's a really fast-moving situation, as we said. Let's do a little stock take on the situation. As of this point, to sort of level set, the conflict is now in its fifth week. That's perhaps longer than many in the market had originally expected it to last. Market price action is, of course, very volatile, but on the whole, increasingly negative as it prices in more adverse scenarios. The potential stagflationary impulse that this shock could impart and parsing signals from the White House is difficult, to say the least. On the one hand, some way marks towards a potential de-escalation are being met, including the indirect negotiations between the US and Iran seemingly brokered by Pakistan, a sense that perhaps President Trump wants to follow what is now a relatively well-established playbook of de-escalating when the market reaction gets too adverse, the so-called ‘Taco’. But on the other hand, plenty of escalatory way marks are also being hit, not the least of which is the ongoing closure of the Strait of Hormuz, the lack of a clear plan to reopen it, the mounting impact to oil, gas, fertiliser and other commodity markets. And in addition, more US infantry troops are being deployed to the Persian Gulf. There is a potential ground invasion, perhaps to seize Iran's oil export terminal at Kharg Island. So needless to say, volatile markets that have struggled to price the outlook here. And amid all that, Victoria, I want to ask what stands out to you in terms of the market price action investor flows over the four weeks of this conflict?

Victoria Scholar

Yeah, thanks so much for having me. So I'd say that if we kind of put the record surge in Brent crude to one side for a minute, there are a couple of things that really stand out for me. Firstly, it's that the Nasdaq and the Dow are now in correction territory, so down more than 10% from those recent highs. And we've seen that the mega cap tech appears to be bearing the brunt of a lot of that flight-to-safety trade. So we've seen stocks like Nvidia and Microsoft falling sharply. Microsoft is down as much as 25%, which is a remarkable reduction in its market cap for such a structurally significant company to the US economy and markets and global indices as well. And then I think the second thing that really stands out to me is how this energy shock has entirely sort of ripped up the script when it comes to the outlook for interest rates. So in the UK, we're expecting about three rate cuts this year, and there was a strong chance that we would have already had one by now. And now it looks like there could be no change at all. There's even a slight leaning towards a possible hike. At one point last week, the swaps markets were pencilling in four hikes by the end of the year. Now, obviously, they were getting a little bit ahead of themselves, but still really interesting that we've seen this revival of this inflationary threat and how that's led to that huge selloff in government bonds over the last month in the UK, the US, Japan and elsewhere. And then we've seen that gold had its worst month in 17 years. So some real heavy fallout from the higher-for-longer interest rate outlook.

Luke Bartholomew

So having put that historic surge in Brent oil prices to one side there, Victoria, perhaps I can bring it back into focus because I guess it really is the centre of this crisis. And I guess every financial crisis tends to have some asset price, which is at the heart of it. It's the way in which the story is narrated in financial markets in some way. So, you know, with the financial crisis, people were very interested, say in the TED spread, the Treasury euro dollar spread, this measure of interbank liquidity. In the Eurozone sovereign crisis, it was the peripheral spread against Bunds, especially with Italy, the sense of how much risk there was in the periphery, perhaps in the mini budget crisis in the UK a few years back, it was the 30-year gilt. And of course, in this one, it is the oil price. And I think what's interesting about it in this crisis is maybe the oil prices is playing three roles. One, it is just the barometer of the crisis itself, we have a sense of how worried the market is by looking at movements in the oil price. Second, it's the primary vector that transmits this shock into the global economy more broadly, that's what the pain point is. And third, it might be the thing that brings this whole thing to an end, right, in the sense that the point of sensitivity for the Trump administration might be around energy prices and gasoline prices in the US, in particular. So people are watching the oil price to see if we're getting to a particular pain point to cause a shift in the geopolitics. So having set up that significance of the energy price, I'm wondering, do you think at this point, we are adequately capturing all the risks out there?

Victoria Scholar

Well, I completely agree with everything that you just said. And in terms of the magnitude, clearly, oil has been the big kind of notable mover by a long way. We know that Brent is on track to log a record monthly gain of about 60% in March. And like you say, it's closely intertwined with the economic fallout from the Iran war, given the effective closure of the Strait of Hormuz and also the Kharg Island being so critically important in terms of Iran's oil exports. But I mean, you could argue that oil could be higher, because it's quite far off those 2008 all-time highs when it was almost $150 a barrel. And it does look as though the Iran war is now going into months instead of weeks, which could potentially lead to more upside. But I think the reason why the price has been capped to some extent is because the markets are pricing in hopes of a resolution. And that's supported by some signals from Trump that he is trying to end the war. And the fact that there are these upcoming midterm elections, because I very much doubt that petrol prices in the US being at four-year highs is going to be much of a vote winner. So he's got quite a strong political incentive to reach some kind of peace deal. And then the other thing is that if we put the geopolitics and the war to one side for a minute, the fundamentals at the start of the year were relatively bearish. We had the weak global demand backdrop, and quite a lot of oversupply in the markets. So I think that the markets are currently pricing in a chance that there could be some kind of reversion back to more peacetime, more peacetime state at some point. So the markets have that in the back of their mind. But I think there is a lot of headline risk at the moment. And it's very unpredictable one day to the next, which means that markets are very jittery, very unpredictable, and very volatile.

Luke Bartholomew

And I think you're absolutely right to highlight this question of time as well, how long the conflict lasts, because I think one of the points that we've been making is that the oil price itself is perhaps a nonlinear function of how long the Strait of Hormuz remains closed for, because, you know, we're talking about the oil price here, and what we should stress is that often we're talking about contracts for the delivery of oil, these are futures prices, but at some point, the physical commodity of oil has to be delivered. And the ongoing closure of the Strait of Hormuz means that, you know, we are running at perhaps 10% less oil supply to what the global economy is used to. And at some point, that physical shortage binds, and markets have to clear, you know, demand has to equal supply, at some point, the demand has to be brought down to that new level of supply. And that might require a really quite sharp increase in oil prices. So yeah, that really is just a function of how long the straits remain closed, I think, and, you know, at some point, perhaps those physical shortages do start to bind. But another, I think, interesting development during the conflict that you touched on is perhaps this sort of shift in one of the key themes that was a key point that markets were trading before the conflict, which was this outperformance of EM versus DM, there does seem to have been a sharp reversal on that, that developed markets are outperforming emerging markets. And within that, the US seems to be outperforming the rest of developed markets. And again, that's not really as it was before the conflict, whereas the US seemed to be a relative underperformer. So I wonder, does that sort of shift in the relative performance of these markets make sense to you?

Victoria Scholar

Well, I think we've seen a lot of indiscriminate selling, really, since the start of the Iran war. And this has been driven by kind of sentiment, risk-off sentiment, that general geopolitical uncertainty, and then those fears around inflation. Like you say, emerging markets were hit harder, especially at the beginning. And that was probably as a function of the strength of the dollar, because we've seen these flows back towards the greenback that we weren't seeing in the year before. And then in terms of the US kind of versus the rest of the world, we have seen selling in both. But there have been some real pockets of underperformance in March, like the Kospi, which fell nearly 20%. But that comes off the back of a big surge at the start of the year. And like I mentioned before, the US has been struggling as well with the Dow and the Nasdaq, both in correction territory. So it does feel as though there is a lot of unease and uncertainty when it comes to the outlook for equities at the moment.

Paul Diggle

Do you think there are sectoral stories as well, Victoria? You were talking about some of the country-level differences, but at the start, you also noted this large selloff in some of the big US tech stocks. And maybe there's a sort of narrative that, well, AI is very energy intensive. So it's a possible loser. I see people wanting to make the case that renewables could be a possible winner, if we're worried again about fossil-fuel supply. So talk to us about the sort of possible sectoral implications you might have under the hood in equity markets.

Victoria Scholar

So defence stocks have been very popular because of obviously rising defence spending by governments and that global geopolitical instability. Commodity stocks, of course, have been popular. So things like BP and Glencore in the UK. And what our data showed is that while dividends are usually very popular over a longer-term basis, ii investors have been turning more towards income stocks for that security in this uncertain environment. So shares like Legal & General or Aviva or Taylor Wimpey have been very popular thanks to that steady income appeal. And also, with the recent stock market declines, that's helped to turbocharge some of those yields, it's flattered those dividends. We've also seen that ii investors have been turning more to short-term money market funds. And again, these have been popular over a longer term, but it does feel as though there is a renewed interest in some things like Royal London short-term money market funds, because investors are looking for that safety. And they're looking for less risky products that have a guaranteed income. And then I think it wouldn't be unexpected if we were to see sectors like utilities and healthcare generate increased demand kind of going forward to help weather that potential sort of softer economic outlook as well. That's the kind of sort of playbook of when we get market weakness, the kind of counter-cyclical sectors coming back into play.

Paul Diggle

So clearly, there can be these thematic winners from from increased geopolitical risk, as you were saying there. But I want to also ask about sort of dip buying, and what you might observe on the ii platform, in terms of dip buying, because retail investors can be a really big delta in these kinds of indiscriminate selloff environments. And there's this clear comparison of Liberation Day, where it was actually, I think, in the first instance, large numbers of retail investors who were buying into that dip, and perhaps had a different political view of the outlook and what President Trump was going to do at that point, and sort of were part of the turnaround. So what are you seeing? Or what do you think about dip buying from from retail investor community in this environment?

Victoria Scholar

So in terms of the data, we have seen a lot of dip buying, we've seen that over the last couple of weeks, gold and silver exchange-traded commodities have been on the most bought list. We also find them on the most sold list. So often kind of the most traded, but the buying in terms of volumes tends to outweigh the selling. So it does look as though there is this kind of renewed interest in gold and silver now that it is at more attractive levels. We've also seen that our customers have been buying UK banks, so companies like NatWest and Barclays and Lloyds, all of which have struggled in recent weeks. And that provides some attractive buy the dip opportunities there at a discount. We know that airlines have obviously been hit hard over the last month. The likes of BA's parent company, IAG, and EasyJet. These have been very popular stocks over the last couple of weeks. We know that there's been a lot of travel disruption either to or through the Middle East, and that's weighed on the sector. EasyJet is down nearly 25% over the last month, and our investors have been snapping up these shares on sale. So I think that these savvy investors are clearly hoping for a resolution or a rebound in some of these heavily sold companies or sectors. So when we do get that kind of indiscriminate selling, that does create a lot of opportunities for dip buying if you're feeling brave.

Paul Diggle

Do you think retail investors can be sort of structurally better contrarians than institutional investors? Better at spotting these turning points. I mean, maybe because they're not benchmarked, or they don't have sort of mandate restrictions, or maybe they are more imaginative, freer thinkers. Maybe they have less career risk. What do you think is a structural feature of that different investor base for being contrarians?

Victoria Scholar

Yeah. I mean, I'm obviously a champion of the retail investor, and I think retail investors don't typically spend all day looking at the markets. They're busy people doing lots of interesting things, not just focusing on financial markets all day. But the flip side is that they are less constrained in many ways, and they're free from a lot of pressures that institutional investors face. So they can be a bit more agile and move more quickly. Like you said, they don't have to worry about things like benchmarking, or the difficulty of exiting a position, or what to do with any cash raised. And also, we've seen an explosion of information in the last year, two years, five years, 10 years. So that really helps to level the playing field, and it creates more opportunities for retail investors now than there were however many years ago. So yeah, I think that they can be. Why not?

Luke Bartholomew

And then it's interesting, you said there, Victoria, that gold, precious metals have been both the most bought and perhaps the most sold that you've seen. Because it is quite striking, I think, that gold hasn't necessarily behaved the way you might think it would in a crisis like this. People talk about gold as being a natural hedge to geopolitical risk, and a natural hedge to inflation risk. Well, here we are with a big inflation shock and a big geopolitical shock. And in fact, the price of gold has fallen somewhat. So it doesn't seem to be behaving in the way that people expect. And there are potentially technical reasons for that, maybe because gold has performed so well. Recently, it's a natural place to look for liquidity if you have to sell in your portfolio as a consequence of losses elsewhere. But I'm interested in how big was the retail investor interest in gold going into this conflict, given that pretty historic bull market we saw? And do you think it will be robust to the fact that gold hasn't performed quite as well as we might have expected in this conflict?

Victoria Scholar

Yeah, so there has been a lot of interest in gold over the last year during this whole bull run prior to the war and the earlier selloff this year. And we saw that across exchange-traded funds, but also in terms of gold mining stocks. So large caps like Fresnillo and Endeavour Mining were very popular, and also some of the smaller caps as well. And there is still significant demand for precious metals. Yeah, there was a lot of buying ahead of the war, and perhaps it's eased off a bit, but I think there is still interest there. But in terms of its kind of safe haven status, I think it's lost that appeal over the last year, given what we've seen in terms of price action. It's certainly not behaving like a safe, stable asset, it's acting more like a tech stock or Bitcoin or something. And then, of course, there's the sort of higher-for-longer interest rate talk, which makes life harder for non-yielding assets like gold. But it'll be interesting to see if this ends up being kind of short-term blip and the uptrend resumes, or if this is the end of the bull run and we're starting to see kind of more of a slowdown.

Luke Bartholomew

So gold hasn't been a nice diversifier in this shock. And then, as you said, back at the start there, one of the things that this conflict has brought about is quite a radical repricing in the interest rate environment. So yields are up, which means the prices of bonds are down. So they've also failed to diversify well. And bonds are meant to be the classic portfolio diversifier. They do well at times when perhaps your equities are doing less well. But of course, it's not in these kind of shocks that bonds do well precisely because they push up on inflation and interest rate expectations. These negative supply shocks are not ones in which bonds protect your portfolio. And as we said, gold hasn't either. So where do you think investors might look for diversification in a world of perhaps more of these kind of geopolitical shocks?

Victoria Scholar

So I'd say that at ii, we really believe in long-term investing with a diversified portfolio across asset classes, sectors, and geography. So we try not to worry too much about selloffs, as we know that they are part and parcel of investing in the markets over the long term. So trying to focus on the long-term outlook rather than the short-term fluctuations. Having said that, I'd say that the US dollar has been behaving like a safe haven in a way that gold and bonds haven't. Probably some exposure to commodities is appropriate as a smaller percentage of a balanced portfolio that can provide some support in the current market environment. And then I think for investors that are feeling brave, as we kind of pointed to already, there are quite a lot of opportunities now where assets have sold off heavily. And so there are selective opportunities within sectors, like for example, in the UK banks, where NatWest had a very strong financial performance that it outlined in February, and now it's 20% below those recent highs. So there are opportunities where companies have been oversold.

Luke Bartholomew

Yeah, I think that's exactly right. And then just one other thought that I might add is that it's certainly the case that bonds have been concentrating on inflation risk at the moment, and that's why they haven't hedged. But to the extent to which investor attention perhaps turns at some point to the growth shock, whether this is going to tip many economies into recession, perhaps then the prospect of interest rate cuts and then positive performance from bonds will look rather better. But that is all we have time for this week. So as ever, please forgive me if I ask you once again to like, subscribe, wherever it is that you get your podcast. And then all that remains is for me to thank Victoria for joining us today for her excellent contribution and her insights. So thanks, Victoria. And thanks all for listening. Speak again soon.

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