Any time you have serious tensions between nations in a time of war there is the potential for escalation. From an investor perspective, I am concerned with the recent developments in the Middle East as there is obviously the potential for even further escalation given the recent attacks on Israel by Iran. That said, at this stage, my view is that it is not in the interests of any country to escalate from here and all things being equal I am hopeful that this doesn’t go further – for now. Keep in mind that any of my comments here are only in relation to their impact on investors and investment markets.

It appears that Iran flagged their attacks ahead of time, giving the US and Israel sufficient room to ready their defences. When the attack came, the Israeli air defence, supported by the US military and other allies was able to fend of almost all of the 200 plus drones and missiles sent their way. I’ve also read reports suggesting that Iran indicated that these attacks are the full extent of their response.

If Iran wanted to maximise the impact and damage, I would have expected them to launch a surprise attack. You would not provide any communication as to the extent or timing of the attack unless it was for misinformation. While that remains to be seen, if that communication is truthful then it suggests the attack was less about aggression or even revenge and more about perception at this point.

It was widely expected that there would be a miliary response of some kind from Iran following the Israeli attack on the Iranian consulate in Syria. Perception matters for all sides, most importantly in the military sense because leaders of a nation cannot appear weak in the face of an attack. A tepid response from a leader in the eyes of their citizens would weaken their leadership and possibly expose them to challenges internally.

Considering that a response was inevitable, and expected, what matters then is the size and scale of a response. In this case, it appears to have been relatively well navigated by Israel and its allies. Iran has responded. Israel has successfully defended itself. Again, from an investor perspective, markets are on edge right now and, in my view, rightfully so given the likelihood of a further Israeli counterattack. What matters most for investment markets is the scale of their response.

A forceful but measured counter will mean It’s still very possible that the situation can settle from here. Certainly, the US and its allies do not want to be dragged in to a war. Of course, any of this can change in an instant. Further disproportionate attacks from either Iran or Israel from here would amount to a serious escalation in my view and I would be concerned about the conflict broadening and the subsequent flow on effects.

So, while there remains a serious risk of escalation simply because war is unpredictable, my read is that this situation can be contained and managed for now. Of course, in a situation as perilously positioned as with tensions in the Middle East, you can never be particularly confident. These are the most complex dynamics of geopolitics because turning the other cheek isn’t an option.

While the situation in the Middle East is extremely complicated, it is made even more so because there are serious implications for the global economy. In this case, Iran’s involvement, and the potential for disruption in the supply of oil would have wide-ranging implications. Lower supply would translate into much higher energy prices and once again put upward pressure on inflation.

As we head towards the USA presidential election in November, increased inflation would create a situation that would bring the cost-of-living crisis to the fore of the election debate and potentially threatens the Biden leadership. It’s possible that this impact the outcome of the election but it’s also possible that it impacts the Biden government response to the situation in the Middle East.

The US political environment is so polarised and divisive that the upcoming election will not only impact the US but also the structure of the world. Whoever wins the presidency will lead a future path that will be dramatically different from the one that would exist if their challenger were to win.

This will be a sliding doors moment for the power structure of the rest of the world. All the nations involved in conflict around the world, or potentially involved in conflict, are well aware of this. So perhaps it’s less about whether geopolitical tensions will rise, but more about where they will arise.

General Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

There are dozens of different types of risks and biases that investors need to consider when making investment decisions. Some such as market risk, concentration risk, credit risk, liquidity risk and time horizon risk are easier to quantify and are well understood. Others such as recency bias, confirmation bias and herd mentality are more nuanced and require some self-reflection to mitigate or offset their impact.

Share markets have been kind to investors over the past several months, and our portfolios have enjoyed solid returns on the back of this. However, the recent buoyancy in share markets has not changed my underlying cautiousness regarding the risks that investors face. I still think the world is precariously placed, even though the share market doesn’t seem particularly concerned now. Wars can escalate, inflation may not be over, the list goes on.

Investors have become complacent and seem to ignore any potential for bad news. Rather than factor in risks more conservatively, the share market has taken an attitude that everything is great until it has been proven that it is not. This binary thinking isn’t very smart because it doesn’t account for the reality that there are indeed risks that exist with varying degrees of probability. These risks need to be factored in.

To make the math simple, let’s imagine there are 2 separate global events, event A and event B. Let’s further assume each event has a 50% probability of occurring in the next 12 months and would result in a 20% decline in the share market. Based on the probability of each of the 2 events happening, the following outlines the combination of possible outcomes and their probabilities of occurring:

1. 25% chance that neither event A nor event B occur.

2. 50% chance that either event A or event B occurs.

3. 25% chance that both event A and event B occur.

Unfortunately, investment markets often misprice event risk. Perhaps it is due to complacency or the intangible nature of assessing risk. Nevertheless, in the absence of an event occurring, the default assessment of these risks by investors in the current market seems to be to ignore it until it happens.

This might turn out to be ok in the 25% chance where neither of the 2 events occurred. But that results in a mispricing of risk until that point because there was a 75% chance of a negative outcome whereby at least one of the events occurs. If the events do occur markets need to adjust much more aggressively. In the basic scenario I outlined above, there is a 50% chance that one or the other event occurs, resulting in a 20% fall. While there is also a 25% chance that both events occur leading to a much larger fall in the share market.

In reality, there are many risks at play of varying probability and consequence. But in today’s complex geopolitical and global economic environment, where there are many more event risks than usual, the prudent assessment of risk is imperative. It’s critical to think differently and ensure you don’t get caught up in the herd mentality as markets throw caution to the wind. Consider the way various biases impact your thinking and assessment of risk.

So, while investment markets and many investors seem to have taken a head in the sand approach to considering these risks, I am happy to carefully consider them. It means that we continue to take profit from time to time as share markets go ever higher. We want to be prepared for the day when one or more of these events do occur because eventually, they will.

General Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.