With shipping traffic through the Strait of Hormuz grinding to a halt, Brent crude prices have already soared by nearly 50 per cent since late February.
ST PHOTO: NG SOR LUAN
SINGAPORE - It can be easy to lose sight of investment goals in the fog of war. While it is impossible to say with any certainty just how the conflict in the Middle East will pan out, setting a clear plan of action is paramount to ensuring portfolio resilience.
For investors, the key danger to prepare for is whether this evolves into a full-blown global oil shock. The short answer: not yet. The long answer: risks are building.
With shipping traffic through the Strait of Hormuz grinding to a de facto halt, Brent Crude prices have already soared by nearly 50 per cent since late February. And if the closure of Hormuz continues to paralyse nearly a fifth of global oil supply, this could quickly become the largest oil supply shock in modern history.
Financial markets have swiftly repriced the risk of higher energy prices. Short-term yields have soared as expectations for central bank easing were sharply scaled back. The US dollar has strengthened on safe haven demand and improved terms of trade, given the US’ status as a net energy exporter. Meanwhile, gold has retreated amid higher interest rate expectations and global equities have also come under pressure, though declines remain more contained.
Not time to head for the bunkers
Despite the growing risks, history shows that geopolitical shocks are buying opportunities, especially if they are short-lived.
There are notable exceptions. The 1973 oil embargo, for instance, saw oil prices quadruple, spurring a multi-year inflation shock and global recession, but staying invested has been the best strategy for long-term and well-diversified investors.
This time, starting conditions are benign. Large fiscal stimulus and alternative energy sources, price caps and strategic reserves can help moderate second-round effects. And inflation is now lower than it was during the 2022 energy price spike.
Indeed, in a scenario where the Hormuz situation stabilises in the next few weeks and oil prices are contained to a range of US$85 to US$90 per barrel, we think the US Federal Reserve can still cut rates once or twice in 2026, global growth will remain robust and global earnings will rise more than 10 per cent.
These support our preference for a diversified mix of cyclical and secular equity exposures globally, with the S&P 500 forecast to reach 7,700 by end-2026.
But if shocks become sustained – and feed into inflation and growth – the playbook changes.
The next shoe to drop?
In a risk case where the Strait of Hormuz stays shut past early April, we think oil could spike to US$120 per barrel and remain there for several months. The damage to risk assets could become non-linear.
The immediate effect would be higher inflation, especially in the US, where this pass-through to the pump is relatively direct.
In contrast, many Asian economies – including Japan, South Korea and China – have mechanisms to cushion consumers via subsidies or price controls. However, these measures do not eliminate the shock; they merely shift it to fiscal balances or corporate margins.
Over time, the impact would shift from inflation to growth, as higher costs hurt consumption, corporate margins and economic activity. At that stage, central banks may pivot back towards easing – but not before volatility rises.
This two-phase dynamic – first inflation, then growth – explains why markets remain focused on rates today, but could shift quickly towards growth risks if the shock deepens.
As recessionary risks rise, we think the S&P 500 could retrace back to 4,500. Oil-dependent and cyclical markets, as well as previous outperformers, would likely suffer the most. The dollar may strengthen in the near term before succumbing to deeper Fed cuts, which could total over 150 basis points to 2 per cent by the end of the year.
Asia: Exposed, but not equally vulnerable
For Asia, regional gross domestic product growth could sink below 4 per cent. But the vulnerability varies.
Malaysia stands out as a net energy exporter and a relative beneficiary. At the other end, economies such as India and parts of South-east Asia are more exposed due to import dependence and limited buffers. China, despite importing nearly 40 per cent of its crude from the Middle East, is buffered by its large reserves, policy flexibility and alternative suppliers.
As a highly open economy, Singapore is exposed to energy price shocks, but its diversified sourcing and strong fiscal position reduce the risk of physical disruption. The key vulnerability lies in price transmission rather than supply shortages.
Rising inflation could prompt rate hikes in Indonesia, the Philippines and India. Equities could see a peak-to-trough drop of more than 20 per cent, with high-beta and oil-importing markets like India, South Korea and Taiwan hit hardest. Asia high-yield credit would also see a larger correction, while currencies of net-energy importers would be most vulnerable.
The playbook for a prolonged conflict
Investors should progressively prepare for such risks as the war drags on.
First, maintain adequate liquidity. This does not mean dashing into cash, which can still be a longer-term drag on portfolio returns. But having adequate liquidity can help avoid forced selling of positions and allows for flexibility to take advantage of dislocations that arise.
Second, diversify effectively. Recent volatility in government bonds and gold present attractively priced opportunities to diversify. Within equities, we recommend against over-concentration in areas like artificial intelligence, where we are taking a more globally diversified approach across the supply chain and different layers of the AI stack.
Third, add hedges to mitigate large drawdowns while maintaining exposure to potential rebounds. These can include equity downside risk management, upside hedges for safe haven currencies and commodity exposure.
Finally, progressively de-risk as the crisis persists. While we remain risk-on overall, we have been incrementally adjusting our positions in the past month to reflect the evolving situation. We have reduced exposure to US information technology, communication services, global banks, European and Indian equities and upgraded defensive segments such as Switzerland, global healthcare and the US dollar.
Likewise, we have added short-duration quality bonds and upgraded US Treasuries to Attractive. Bond markets remain focused on near-term inflation and continue to underappreciate medium-term growth risks if elevated energy prices persist.
Taking further steps to de-risk portfolios would be warranted if the situation deteriorates further.
The writer is the Asia-Pacific head of UBS Global Wealth Management’s Chief Investment Office.
