People stand outside a mosque destroyed by an Israeli air strike in Khan Younis, Gaza Strip, on October 8. Photo: AP
Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
Israel-Hamas war shows limits of forecasting in an age of uncertainty
it has become clear investors are out of their depth when it comes to gauging non-economic threats, particularly geopolitical risk
If the past several years have taught anything, it is that the world is a more unpredictable place. Analytical humility is vital for those trying to make sense of it all
Boxer Mike Tyson’s famous quote – “Everyone has a plan until they get punched in the face” – is timeless. It applies to a wide variety of circumstances. In financial markets, it serves as a reminder of the acute challenges in making predictions about the performance of the global economy and asset prices in a time of increasing uncertainty.
Up until the 2008 financial crisis, international investors never took seriously non-economic risks – those that are harder to quantify, such as political risk, wars and revolutions. This was because such threats were perceived to be a problem faced by unstable emerging markets.
Yet, following the outbreak of the euro-zone crisis in 2011-12, which showed how difficult it is to maintain a monetary union consisting of sovereign states with diverging economic policies, markets began to pay more attention to political risk.
The unexpected decision by Britain in June 2016 to vote to leave the European Union, followed by Donald Trump’s victory in the US presidential election five months later, showed that even the supposedly safest advanced economies can face political shocks.
What has transpired since – the first global pandemic in a century, the largest armed conflict in Europe since World War II and the cost-of-living crisis stemming from the biggest inflation shock since the 1970s – has heightened investors’ sensitivity to non-quantitative factors when assessing risks to the global economy and markets.
However, it has also become clear that investors are out of their depth when it comes to gauging non-economic threats, particularly geopolitical risk. Markets have enough problems predicting whether the United States will suffer a recession or when the Bank of Japan will begin raising interest rates, never mind determining the impact of dramatic shifts in the geopolitical landscape.
Yet, it is these unquantifiable factors that have a greater capacity to shock. The latest one is the Gaza-based militant group Hamas’ deadly attack on Israel last weekend, which was launched on the 50th anniversary of the Yom Kippur War that precipitated the Arab oil embargo.
Focusing on the economic and market implications of Hamas’ assault trivialises the heavy loss of life, which already exceeds 2,300 between the two sides. Even so, the geopolitical stakes are extremely high.
Not only was the surprise attack the worst inside the Jewish state since its founding in 1948, it risks triggering a wider destabilisation of the Middle East, particularly if Iran – which supports Hamas and other militant groups in the region, notably the Lebanese militia Hezbollah – becomes actively involved in the conflict.
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Soldiers find 'massacre' in Israeli village as air strikes continue to pummel Gaza
Soldiers find 'massacre' in Israeli village as air strikes continue to pummel Gaza
Investors, not surprisingly, perceive the war through the prism of oil markets, especially at a time when inflationary pressures have abated and growth is slowing, raising expectations of interest rate cuts. If the conflict draws in Iran – which continues to be a major oil producer despite facing US sanctions – oil prices could soar.
On Monday, Bloomberg data showed options markets experienced the biggest swing in favour of bullish bets on oil prices since March last year, when Russia’s full-scale invasion of Ukraine sent markets into a tailspin. Yet, prices are still down more than 10 per cent since late September. This is partly because the global economy is not as reliant on Middle Eastern oil as it was in the 1970s, but it also reflects deep uncertainty over the scope for a regional conflagration.
Yet, if Israel’s own security and intelligence apparatus was unable to anticipate the attack, investors and financial market commentators would do well to refrain from becoming amateur Middle East experts. Terry Haines, founder of Pangaea Policy, was correct in pointing out in a note published on October 8 that “geopolitical ‘experts’ shouldn’t be trusted by investors today for the Middle East direction of travel”.
Predictions are a mug’s game, no more so than in geopolitics. Former US defence secretary Donald Rumsfeld was right to distinguish between “knowns” and “unknowns”. The former are risks that can be assessed and priced with a degree of accuracy. The latter are unpredictable events that cannot be priced or hedged against, no matter how determined investors are to make sense of markets in the hope of being on the winning side of a trade.
If the past several years have taught investors anything, it is that the world is a more uncertain place. Culture, history and political science are now as consequential as finance and economics. Analytical humility on the part of investors is more important than ever, otherwise the punches will become harder and harder.
