Brad Simpson on rising Iran–Israel tensions and the implications for markets

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Tensions in the Middle East have escalated following Iran's attack on Israel. So how should investors be weighing the potential risks to the global economy and financial markets? Joining us now to discuss is Brad Simpson, Chief Wealth Strategist at TD Wealth. Brad, always great to have you with us.

Thanks so much for having me, Greg. So obviously, this is a highly volatile situation. We don't, of course, know how things are going to play out. But you've been taking a look at some scenarios that could unfold. Walk us through them.

Yeah, I think I would first start saying out that if you tried to find a good news for this from a financial market perspective anyways, of course, there's none when it comes to the human cost of it, but for the financial markets was that this was pretty well-telegraphed. And if you look at the activity in equity markets when they opened up on the Monday and fixed income markets, you could see that the response was pretty muted.

And I think that a lot of that has to do with, I think, most of the market was really expecting that this would happen. And then, of course, you throw on, if you looked at it in terms of a military engagement, it would be hard to conclude that from an Iranian perspective that it was a successful one and through an Israeli perspective and their allies would be a very successful defense. So that, I think, led to a lot of the positive-- what we saw in the market on the way in.

Now kind of going where we go through there is that we think that, from here, clearly, the temperature's turned up in the environment there now. And we think this is something that's going to continue to build, to play out, not only in the months ahead but probably the years ahead as well.

So with that, we thought through a way of looking at this is that we have these kind of scenario analysis that we work out. And starting out with looking at this as a limited scale security crisis, we have dialed that down. And we've kept that to where that was at 45%, which is where we were in February.

A change that we've made is saying is that this is a larger security crisis in the area that could expand across the whole region. We increased that by 5% up to a 40% likelihood. And then, on the other side, we also looked at this and say, look at in terms of what's the potential for there to be a de-escalation in the area, that we reduced that from a 20% likelihood and took that down to 15%. So all in all, in our way of looking at that, looking at the world there, is that increase-- that this has increased the temperature here. And from there, we'll just keep following and see how this rolls out.

So as you took a look at these different scenarios and sort of changed your outlook based on the events of recent days, you also did a bit of a work on what it could mean for bonds, stocks, and commodities-- different asset classes. Walk me through that. Let's start with bonds.

Sure. So for fixed income, really, the first question is it leads to interest rates. And if you're going to be talking about interest rates, of course, you're going to be talking about inflation. And so because it is in the area of the world where so much of the oil is immediately a lead to what's going to be the impact on the price of oil?

And, of course, if oil starts to go up, which we've seen over the last few weeks, a move from kind of the mid $80 zone up into to $90 going into this attack on the weekend, fell off about a percent or so on the last couple of days here again. But if we saw, really, a change in the oil price, and, let's say, like for Brent Crude over $100, then you'd start to see more of an impact on inflation, which could have a potential impact on interest rates from here. We don't think that's what we're going to see, certainly in the short and mid-term of this anyways.

So the other side of the coin, of course, then is in times like this is there's a flight to safety. And a flight to safety means that there would be a real potential for the market and folks to start moving more into US bonds, which has the potential to push interest rates down. And so that is also-- that's actually a net positive.

So we remain with our fixed income weighting as we are modestly overweight fixed income. And we continue to be very comfortable with that positioning there.

What about on the equity side? We'll get back to the commodities because, obviously, there was an interplay between commodities and bonds. Let's talk stocks.

Sure, yeah. Of course, that's, I think, the big one, I think, for investors right now, and especially if you want to frame that through the lens of looking at where most of the global market move has been. And that is the story of the S&P 500. So if you look at it since October 2023, you've seen the S&P rally about 25%. And put on to that in dollar terms, it's added about $12 trillion in market capitalization. This is a market that has moved an awful lot. And it's one that there's been almost no volatility for the last-- let's call it-- 5, 6 months either.

So this is a market looking for something to build-- to correct on. And so I would say because this was so well-telegraphed, this ended up not being the type of catalyst that the market was looking for. But if you look at over the last few weeks, we have started to see a little bit of correction. And that correction, we think that we're probably going to see more of that in the weeks ahead.

There is a lot of headwind here just to try to take some steam out of this market, if you will. And so for that, we think that this is a little bit of a cautionary tale, which leads to right now, where weighting in equity markets are neutral, which is what has been going into this. And we think that's a really good way of looking at that right now.

We touched on oil and the interplay it could have, obviously, on inflation, which could feed back to the bond market. What about other commodities coming out of all this?

Now, look, the commodity story, I think, is the side that's really interesting for a couple reasons. And one, starting out, is if you think about what our job is to do with-- me and my team is really thinking about how do you allocate capital, asset allocation and then risk management?

And so for us, we're going into this-- if you look back into the beginning of the year or even into the back into last November, when we were doing our year ahead, one of the points that we made in our year ahead document was that we foresaw that there's obviously a lot of turbulence in this area of the world. And one of the things you really want to look at is the potential for an increased sort of military and warfare, which could lead to more pressure on oil prices. So one of those is we thought that making sure that we were well weighted towards oil based on that made sense in the likelihood that there was an increase in tensions.

The other part is that we thought and we continue to think is that we modestly overweight, commodities as a whole. And for us, this is a strategic allocation and also a tactical one, meaning we think that investors need to have a continuous position in commodity side of the market. And the reason for that is it's a really good hedge.

And if we look at how the market has been moving over the last six months, every time that there's an increase in tension in anywhere, either where the two wars are going on right now in Ukraine and also in Israel, what we're seeing is that commodities have been playing the role of a very good diversifier. And we continue to think that makes an awful lot of sense here.

Brad, you and I have had a lot of discussions about having longer-term thinking about the markets. And as you talk about allocating capital off the top, you said these developments-- although they can be fast-moving-- implications for weeks, months, perhaps even years? What should an investor, when they pull back and they think about these kind of geopolitical tensions, about their portfolio?

Well, I think it's an important part is I think one of the things that helps is that one of the things we've been writing a lot about over the last couple of years is that in this era of deglobalization, we now have an-- we now unfortunately live in an era where there's going to be more of this sort of strife globally, and meaning that one can basically build their investment portfolio taking that into consideration.

So the starting point of that really that comes down to is making sure that you're allocating a well-diversified investment portfolio that's also directional. And what that simply in English means is that you shouldn't be allocating your portfolios solely based on what you own, that it's going to go up. You should also be looking at in terms of that it can also go down and means you can be doing hedging there. And you can-- and that's protecting capital. But it also has the potential to protect when volatility kicks up.

And I think if you do that-- and then the last part is, is at the end of the day, making sure that why you're investing, having a financial plan and then having your investments up against the goals and objectives on that so that you stretch out your time horizon. Many of us have long-term time horizons. And one of the things that you can look at is that long-term assets, like equities, that really, it pays off, that even though you could go through eras of different-- of like what we see now, an era of increased warfare, if you look at in times past, as long as you had a long time horizon, your portfolio can not only weather these really well, but you still can see a lot of growth as well. [AUDIO LOGO]

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