23 October 2023, 5:32PM UTC

Chief Investment Office GWM

Investment Research

Israel-Hamas war: Gauging the impact

Weekly - Regional View US

Solita Marcelli, GWM Chief Investment Officer Americas, UBS Financial Services Inc. (UBS FS)

Geopolitical developments have shocked the world, altered the course of

history, and dominated the headlines. But oftentimes, financial markets are
not impacted proportionally.

This looks to be the case two weeks into the latest crisis following Hamas’s
attack on Israel. The broad market reaction to date could be described as
mostly muted. The S&P 500 was actually up slightly in the first week following
the attack, reflecting the view that this currently remains a local conflict with
a mostly local impact to financial assets. While stocks came under pressure
last week, this was more likely due to the sharp rise in yields.

Still, more pronounced moves since the attack in geopolitically sensitive

asset classes like oil (Brent crude up 11%) and gold (up 9%) have brought
questions around side effects for the economy, and the best way to hedge
against any worst-case scenarios.

All eyes on oil: Could prices spiral?

When it comes to the market reaction from here, oil remains the main
transmission mechanism, and a significant move higher is the key risk to
watch. While there is no set oil price that will tip the economy into a recession,
the relationship with the US consumer is very much linear: Every dollar that
gasoline prices rise as a result causes a bit more pain, incrementally redirecting
spending from elsewhere. This, of course, has trickle-down effect to earnings
and complicates the Federal Reserve’s battle against inflation.

As we know from history, geopolitical risk premiums can disappear quickly.

And whether the initial moves intensify will depend on how relationships in
the Middle East evolve among Israel, Hamas, other local and regional players,
and most importantly, Iran.

As of now, we don’t expect oil prices to spiral out of control. We believe the
most likely scenario is that Brent crude oil fluctuates between USD 90/bbl
and USD 100/bbl, alongside any local escalations such as involvement from
Hezbollah. While pressure toward the USD 105–110/bbl range is possible
with an incremental reduction in Iranian exports, there is currently spare
capacity sitting with OPEC+ to help offset the impact.

A more pronounced move above USD 120/bbl likely would only come with
a significant supply disruption. There are a few ways this could feasibly play

This report has been prepared by UBS Financial Services Inc. (UBS FS). Please see important disclaimers and
disclosures at the end of the document.
Weekly - Regional View US

out: through a larger removal of Iranian oil from the market; a closure of the
Strait of Hormuz, which accounts for over 20% of the world’s daily flow; or
by some form of coordinated embargo among Arab countries, similar to the
Yom Kippur War in 1973.

But while none of these outcomes can be ruled out, they are currently
tail risks, in our view. Initial reactions from the US have skewed toward
de-escalation, and with Israel immediately focused on its imminent ground
operation in Gaza, the desire to confront Iran is likely low, at least in the near
term. And even if oil prices did move to extreme levels temporarily, we would
not expect them to be sustained.

Finally, it’s worth noting that what’s most important to the US consumer is
the end-product at the pump. Despite the recent uptick in crude oil prices,
gas prices have actually been falling in the US, and data suggests they may
be relatively less sensitive to spikes in oil prices at the moment.

The bottom line: Our base case is that oil prices remain relatively contained,
and as long as supply disruptions don’t feed through to the consumer for a
prolonged period, the Israel-Hamas war is unlikely to be a main driver of the
macro picture for now.

To hedge or not to hedge: Is gold the answer?

Outside of uncertainty around oil prices, perhaps the most common

investment-related question accompanying any war or crisis is, “Should I buy
gold?” If you look at history, while no two risk-off events are identical, the
percent change in the gold price has been around the mid-single digits, on
average.

Once again, we’ve seen gold prove its worth as a geopolitical hedge in
the days and weeks following Hamas’s attack. This supports our view that
gold’s importance in long-term portfolios has only increased in recent years
alongside geopolitical unrest, and we believe investors should hold onto
existing positions despite the latest rally.

Still, we would remain cautious in chasing the recent move too aggressively.
To be a buyer of gold here, you must believe this conflict is going to
meaningfully escalate—which is not yet our base case. And in the absence of
a major escalation, you’re left with a relatively uncertain fundamental picture.
We expect the US dollar to remain resilient in the coming months, and while
correlations between gold and the USD have broken down recently, that
usually does not last for too long.

To see a sustainable rally, we will likely need to see ETF flows turning positive
again. We saw this in the initial stages of the Silicon Valley Bank crisis but
have yet to see signs of this trend reigniting meaningfully.

Bottom line: How to invest?

First, it’s important to remember that geopolitical events have rarely caused a
global recession or left a lasting mark on markets. Therefore, the best course
of action is almost always to stay diversified and stay invested. But when
answering specific questions on how to position, each event needs to be
assessed alongside the fundamental backdrop.

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In this case, the Israel-Hamas war comes at a time of already elevated

geopolitical tensions, with the ongoing war in Ukraine, and the intense rivalry
between the US and China.

At the same time, even though the US economy has remained very resilient,
we expect growth to slow in the fourth quarter, inflation to continue to cool,
and yields to trend lower over the next 12 months.

Against this backdrop, we continue to prefer fixed income to equities, and

recommend investors consider buying high-quality bonds, which now boast
great potential for price appreciation alongside compounding.

Within equities, we were already positive on the energy sector prior to the
attack by Hamas, given our view that the supply-and-demand backdrop
was supportive of current oil prices, among other factors. The war further
supports our view on energy, which can serve as a relative hedge within sector
allocations against the risk of a further escalation and rise in oil prices.

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