We live in tumultuous times. The markets remain volatile. Several countries remain at war. And global markets rarely respond well to instability and uncertainty.
The war between Israel and Hamas, started by the Palestinian Hamas group’s October 7 attack, could become protracted and increasingly complex. Banking stability, corporate profits and energy supplies aren’t threatened — yet, but the war is still young. While financial markets haven’t felt the direct effects of this developing war, it’s important to watch several areas should it escalate.
2024 Oil Supplies
After the attack, crude oil prices jumped about 4%, which isn’t uncommon as markets have historically factored in the perception of higher risk to justify an added “fear premium” to prices. This increase was relatively small, and should the oil market function with minimal disruption, carrying on with a “business as usual” approach, the hike will fade quickly.
However, geopolitical changes could affect oil supplies next year and potentially carry implications for the U.S. presidential election. First are the Saudi oil supplies. Before the attack, the Biden administration was working to broker a deal between Saudi Arabia and Israel in which the countries would establish formal relationships — for the first time in history. The nations prepared to make concessions to the other, with the U.S. facilitating this deal by offering Saudi Arabia defense guaranteed.
Some analysts theorized that the deal would also include Saudi Arabia pumping more oil next year to help keep U.S. gas prices down. However, the war may lead to Israel and Saudi Arabia tabling their deal for now — and the Saudis opting not to boost oil production in 2024.
A research note published by Goldman Sachs on October 19 said, “We see more support for tighter oil supply and higher oil prices over the long term as diplomatic progress on a security deal with Saudi Arabia is likely to face significant headwinds during a period of heightened military activity in the Middle East. Speculation that Saudi Arabia could ease its oil production cuts to build goodwill for a security deal with the U.S. has ramped up, but the potential for [October 7th’s] events to spark a broader regional conflict will likely place any further progress on hold.”
Another wildcard for 2024? Iranian oil. In September, the U.S. unfroze $6 billion in Iranian funds as part of a hostage swap. This agreement was reached after months of negotiations and led to the release of five wrongfully detained American citizens from Iran and five Iranian citizens from the U.S. The funds were not directly released to the Iranian government but are held by a trust fund in Qatar and released in installments to purchase humanitarian goods.
Any suspicion of Iran’s assistance to Hamas could force the Biden administration to tighten sanctions, according to an analysis by ClearView Energy Partners. Another analyst from Lipow Oil Associates also noted that Iran’s involvement in the war could be critical in determining the conflict’s impact — or lack thereof — on oil prices. Closure of the Strait of Hormuz, located between Iran and Oman and which produces 17 to 18 million barrels of oil daily, could lead to $20 to $30 per barrel price increases in oil, driving a surge in gas prices in the U.S.
However, it’s unlikely that we’ll see a repeat of the Arab oil embargo — which followed the invasion of Israel in the 1970s — since Arab states are more friendly to Israel today. That embargo contributed to a significant recession in the West and fuel shortages in the U.S. It also led to a restructuring of the U.S. economy and the country’s relationship with Saudi Arabia.
Insuring Against a Conflict
If you’re an investor, it’s possible to insure against a conflict. Buying oil stocks, defense stocks and Treasurys still delivers high profits and bond yields. Expected earnings for U.S. oil companies are projected to be high — though not as high as Q4 2022. (Even if earnings fell to the average since 2005, the forward price-to-earnings multiple of the sector would be pushed to its long-run average.)
The ongoing Ukraine-Russia conflict and a new cold war between China and the U.S. have boosted defense stocks, which are cheaper to buy than earlier this year. They’re also, however, exposed to tumultuous domestic politics (like the financial support for Ukraine’s exclusion from September’s stopgap spending bill). Recent gains price more weapons demand — Northrop Grumman, with its 11% gain, joins four other defense contractors in the S&P’s top five performers.
While investors rushed to typical safe-haven commodities like the U.S. dollar and gold immediately after the October 7 attack, most investors have settled into a holding pattern. Forbes analysts theorize that the dollar could become too strong if similar rushes happen in the future, which would raise the cost of American exports beyond the reach of foreign buyers.
Top Financial Stability Concerns
An October 20 survey by the Fed shows top concerns include persistent inflation keeping interest rates higher — and potential losses in the commercial real estate sector.
Three-quarters of respondents in the central bank’s semiannual report cited these issues as prominent near-term risks, followed by concerns about bank stability. Other key findings of top risks included 44% citing economic weakness in China. The Ukraine-Russia war slipped to the 11th most cited concern (from its number one spot of concern one year ago).
The Fed found that although prices have declined amid high office vacancies, CRE valuations remain elevated. It cautioned that an unexpectedly slowing economy could strain some businesses — or cause them to close. The Fed’s Financial Stability Report noted a correction in office property valuations plus a mild recession could lead to “significant losses for a range of financial institutions with sizable exposures, including some regional and community banks and insurance companies.”
The overall banking system is sound, but some banks continue dealing with “sizable” declines in the fair value of certain assets amidst rapid interest rate increases. Overall, though, banks still have significant liquidity levels. Deposit outflows and volatility have decreased since H1 2023.
Looking Ahead to 2024
CRE investment will face challenges going into 2024 due to various factors, including rising interest rates, ongoing economic uncertainty and continued geopolitical tensions. Despite these challenges, some areas of the CRE market are expected to perform well next year:
- Industrial real estate demand will remain strong, driven by the growth of e-commerce.
- Data center real estate demand will also remain strong, driven by the growth of cloud computing and big data.
- Life sciences real estate demand is expected to grow, driven by an aging population and an increased focus on biotechnology.
Are you a commercial real estate investor or looking for a specific property to meet your company’s needs? We invite you to talk to the professionals at CREA United: an organization of CRE professionals from 92 firms representing all disciplines within the CRE industry, from brokers to subcontractors, financial services to security systems, interior designers to architects, movers to IT, and more.
