Source: Bloomberg, oil price and oil volatility data from 30.07.21 to 30.07.26
What is the answer to the US $ 64 million question in markets?
There is often a big question in financial markets. These become big questions because they have high impact and low-visibility characteristics, as well as generally being quite binary in nature. These are questions that are allowed to build, unanswered, over time.
Currently there are probably two big questions facing markets. Very front of mind for markets is what is going to happen in the tech space, especially regarding AIrelated spending? In the background, though only just, is the situation in the Middle East. The former is expressed in the volatility within big tech and semis. The latter is expressed most clearly through the oil price and its volatility, with oil volatility now at a three-month high, and at levels well above those seen during much of the last five years, as seen in the chart above.
Oil price and its volatility
Ultimately, markets care most about economic growth and inflation. Spending on AI has no doubt buoyed growth, and tech in general is now a massive
part of economies and stock markets, while oil is still a significant driver of inflation expectations. This is the high impact risk, and they both have low visibility, especially geopolitical risk.
Markets interpret the questions to be binary but that probably says more about how the human mind tends to simplify complex questions, for example, fight or flight, and the binary nature of numbers.
By their very nature, these big questions dominate the headlines and price moves, and they tend to draw investors in and become self-feeding. This is where we try to stay pragmatic. What do we know more than the market about whether the AI bubble has burst or whether and when peace is going to break out in the Middle East? Clearly, we don’ t, though it’ s very tempting to have a view and pretend we do.
Instead, we go back to maths, or portfolio construction, and keep ourselves grounded in pragmatism. For example, we’ ve recently added an oil ETC to portfolios again. As military activity in the Middle East has increased, this position adds to our larger than normal US dollar position to help diversify equity risk. We retain
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