Your portfolio was built for cheap oil. That world is gone

Are we living in the 1970s? I can’t tell you, I wasn’t there, but it’s an interesting analogy.

The fear of inflation, the eroding value of cash, and now spiking oil prices.

Of course, nothing can repeat exactly. The event that’s said to have launched hyperinflation in the 1970s, the Yom Kippur War, only lasted 20 days.

We’re now approaching thirty days in this Iranian conflict with the US and Israel.

So, maybe we’re not living in the 70s at all, but something far worse?

But it’s not so much the war that’s important here; it’s the FLOW of oil.

For now, the Strait remains shut except for a few renegade exceptions, like Japan.

Japan is reportedly in talks with Iran to ensure the safe passage of its oil vessels moving through the Strait of Hormuz.

As a long-term ally of the US, it’s a meaningful development that highlights that when push comes to shove, energy matters more than friends.

Japan funnels about 90 per cent of its oil shipments through this strait. No doubt, it’s keen to make a deal.

There are also reports that Iran is looking to charge vessels a $2 million ‘toll fee’ in order to pass through the Strait. Assurance for tankers that they won’t be sunk if they pay up.

Could those who pay the toll secure lower insurance premiums? It’s another unknown that could free up the bottleneck.

But it could also provide Iran with a critical source of additional war revenue. Capitalism is alive and well in the Iranian regime.

Pre-War, up to 140 ships passed through the Hormuz Strait, including roughly 60 oil/gas tankers. It seems Iran now has an opportunity to finally monetise its geographical advantage.

Let’s assume the daily count lifts to just a fraction of these pre-war numbers in the coming weeks; it could help sustain Iran’s war effort against the US and Israel. And that’s potentially putting into motion a war that deadlocks rather than resolves.

So, here we are, almost thirty days into the war and the oil flow remains pretty much shut.

So, what does history tell us?

While the Yom Kippur War lasted just 20 days, oil flows to the West remained shut for much longer than that.

Arab producers continued a strict oil embargo against the West for around 5 months as retaliation for their support of Israel in the Middle East.

And once oil began to flow (post-embargo), oil prices remained stubbornly high.

But the consequences went far beyond that…

6 months after the Yom Kippur War began, the US Dow Jones Industrial Average [NYSE: DJI] fell 17% from its 1973 top.

But the real stock market crash didn’t take place until July 1974, about 8 months AFTER the start of the conflict.

And that’s the timeline that should be on investors’ radar.

From the 1973 pre-war top to the 1974 stock market bottom, the DJI fell 45%. It’s not unreasonable to assume that today’s richly valued tech-heavy Nasdaq would have fared much worse back then.

It’s all a tad frightening if we’re drawing on 1970s parallels, and it’s a risk to keep in mind.

If you are in the 1970s ‘analogy’ camp, I’ve marked our current position on the chart above; ‘you are here.’ That’s based on the number of days since the war kicked off in Iran.

It’s conceivable, too, that oil flows could remain constricted for a similar duration, like in the 70s, where embargoes remained in place for 5 months.

And when those embargoes were finally lifted, rather than easing pressure on financial markets, markets revolted. The damage was already baked in.

By July 1974, US interest rates were breaching double figures. And markets entered a cyclical bear market.

But despite broad weakness across financial markets, the outlier remained commodities, particularly energy.

This historical chart from Macro Trends shows the price of West Texas Intermediate (WTI) crude, adjusted for inflation, throughout the 1970s:

Futures traded for a measly $3.50 per barrel prior to the Yom Kippur War in 1973. Postwar, they climbed above $10 per barrel.

And by the end of the 1970’s, oil was trading above $30 per barrel.

About 750% higher from the start of the decade!

Could that happen again? Let’s hope not.

In terms of today's context, before events in Iran, oil traded at about $72 per barrel. The shock came as oil tipped past $100 per barrel, delivering a mere 40% increase.

That was well below the 1970’s oil price shock.

So, clearly, there are differences, and you can’t take the 1970s as a one-for-one blueprint on what could happen next.

So, while it does have its limitations, for investors, using historical analogies like this could prove far more useful than the hyperbolic news cycle.

The 1970s is a helpful yardstick; keep it close. 

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