In the financial markets, geopolitical risks often exhibit a binary nature: for a long time, they pose no issue until suddenly, they do. Consequently, the relationship between geopolitical risks and the financial markets’ response is not straightforward. This complexity partly arises because these risks usually stem from singular events, which markets are adept at overlooking. In this context, possession often marks the end of interest.
Tensions leading up to such an event may escalate so significantly that it might even present a buying opportunity, usually regardless of the outcome. The mere fact that an event has passed renders it irrelevant to financial markets, which often see such situations fizzle out. Even the most irrational dictator can be persuaded under immense pressure, as no one desires extreme escalation. Geopolitical risks only wield significant influence when they impact the economic fundamentals.
Geopolitical Risks Impacting the Global Economy
A prime example of a geopolitical risk with severe consequences was the first oil crisis, during which oil prices tripled in a short span. In the early 1970s, the global economy was far more dependent on oil than it is today. Missteps by central banks in response led to a major inflation issue. Another instance is the fall of the Berlin Wall, marking the end of the Cold War. From the interbellum period to the September 11 attacks in 2001, the peace dividend was reaped, manifesting in financial markets through lower risk premiums and, consequently, higher valuations.
Geopolitical risks can be quantified using a Geopolitical Risk Index, which screens headlines for geopolitical tensions, wars, and terrorism. In times of stress, capital flows into safe havens. Historically, these safe havens included long-term U.S. Treasury bonds. However, after a significant correction of more than 50% in such bonds, many investors now prefer American Big Tech stocks.
Future Outlook for the Middle East
Traditionally, the Middle East has been a geopolitical minefield. As long as incidents remain confined to the Middle East, financial markets tend to disregard them. Although Iran’s attack on Israel marks an escalation, financial markets are more concerned with the aftermath.
Oil remains the Middle East’s primary economic factor, and should Iran decide to block the Strait of Hormuz, oil prices could quickly soar to 100 dollars a barrel. Yet, the underlying cause of the issue is somewhat encouraging. The cause is not the plight of the Palestinians in Gaza or the West Bank but the peace agreements Israel signed with Arab nations in August and September 2020. These countries assisted Israel against the Iranian attack over the weekend, potentially heralding the start of a new interbellum.
The Abraham Accords: The Cause of the Current Crisis
The Abraham Accords are a series of agreements between Israel, the United Arab Emirates, Bahrain, Morocco, and the United States. Before the attacks on October 7, 2023, Israel was also close to a peace agreement with Saudi Arabia, having already made peace with Jordan and Egypt.
The multitude of peace agreements could ultimately aid in resolving the Palestinian issue through a two-state solution. Such a resolution is not in Iran’s interest, as its Quds Force wields significant power in the Middle East, supporting international terrorist activities through Hezbollah, Hamas, Islamic Jihad, the Houthis, and Shiite militias in Iraq and Syria. These organizations would lose a substantial portion of their power if peace were achieved.
A New Iranian Social Contract
Ironically, before the rise of the ayatollahs, Iran was one of the most pro-American countries in the Middle East. This sentiment was not limited to the Shah and his family but extended across large swaths of the Iranian population. The Iranian government now derives its legitimacy in the Middle East through its opposition to Israel and the United States. In this light, the recent attack was primarily aimed at the domestic audience, to the extent that Iran even spread false messages claiming successful strikes.
The social contract between Tehran’s rulers and its people is fraying. The Iranian police harshly penalize women who do not wear the hijab in public. Nevertheless, protests sparked by the death of 22-year-old Mahsa Amini in 2022, who was arrested and killed for improperly wearing her hijab, continue. Given the scale of the protests, a significant portion of the Iranian government’s legitimacy has eroded.
The regime in Tehran survives solely by suppressing its populace. Regaining legitimacy requires radical reforms. Iran’s current approach mirrors that of Argentina during the Falklands conflict in 1982 or Russia’s invasion of Ukraine in 2022.
Han Dieperink, with his extensive background in investment strategy at Auréus Asset Management and prior roles at Rabobank and Schretlen & Co., knows the rhythm of the market well. His insights not only illuminate the current state of play but also hint at the vibrant economic dynamics shaping our future.