Episode 118 | Middle East conflict: evolving dynamics, investment takeaways

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Kevin Headland: I love fractions. So it's my math nerding out going on here.

Macan Nia: Nerd alert. Wow “I love fractions,” I don't think I've ever heard anyone say that.

Kevin Headland: Numerator and denominator, come on!

Macan Nia: Oh gosh…

Kevin Headland: Perfection. That's what equity markets were expecting at the beginning of the year, with valuations reflecting high expectations for growth, stability, and flawless execution. In that environment, even modest disappointments on earnings, policy, or the economy can trigger outsized volatility. When optimism is elevated, concentration risk rises, and the margin for error narrows. While there is no way to predict the catalyst for increased market volatility, there is a need to prepare portfolios for the potential. That's why diversification matters more than ever—not as a hedge against pessimism, but as protection against a world where the good news is already priced in.

Kevin Headland: In this episode of Investments Unplugged, we're back to talking about headlines impacting markets. And of course, there is no bigger headline than the conflict in the Middle East. We'll discuss the current conflict, the risks, but also the opportunity it might present for investors as valuations have come down from their lofty levels. We'll compare today to what investors experienced in 2022 as a result of the jump in oil. And we'll finish off with our views on the private credit landscape. Listen on—this is Investments Unplugged.

Kevin Headland: Welcome back to Investments Unplugged. I'm your host, Kevin Headland, coaching as a strategist. And with me, as always, is my other co-host, Macan Nia. Welcome. Join me, Macan.

Macan Nia: Well, thanks, Kev. Thanks, everyone, for listening in. How are things with you, Kev?

Kevin Headland: Pretty good. We are recording this on April 7th, and I am leaving on vacation on April 11th for a week. So I'm pretty excited.

Macan Nia: Is that in the calendar?

Kevin Headland: I bet you it is. Of course, of course, it's in the calendar. So we are going to do more podcasts or another podcast on kind of from the headlines, of course.

Kevin Headland: The main headline, the Elf in the Room, is day 39 today of the conflict in the Middle East So that's the key topic that everyone's paying attention to when it comes to market moves on a daily basis. And that is what we're going to lead this podcast off with.

Macan Nia: And then we're going to transition to a couple of other opportunities or issues that we might be talking about as well, but all leaned back to the current conflict.

Macan Nia: Yeah. So I guess update on the conflict. It's, as you mentioned, it's April 7^th today. it's interesting to think from the lens of, you know, how quickly we get these podcasts out in the sense that it takes roughly 2 to 3 weeks—2 weeks, sorry—to get our podcast out and think when we were last talking about this. How much has changed in two weeks? And think about when we record the next episode. I think most would think that this hasn't been unwound completely by then, what we'll be talking about.

Macan Nia: But the way I'm looking at it from an investment strategist perspective, you know, when this gets resolved, whenever it gets resolved, oil prices are likely to be, you know, structurally higher than what they were pre-conflict. And for me, it's like the key questions are now, OK, what's that new geopolitical risk premium that commodity traders are now going to put in, embed in oil prices because of what's unfolded? And then what's the new container insurance rates? And also one that's kind of developing is, and this has to do with the things that both sides are looking for, the Iranians want repatriation in some form. The Americans and Israelis obviously do not want to give it to them. So whether maybe Iran imposes like an implicit or an explicit tax in the form of higher transit costs or a fee or a toll that they're talking about, and that also is a premium to oil prices.

Macan Nia: So this is what markets have priced in today, and this is not—again, we have no idea how this is going to unfold and what time frame. But the markets today, and this is what we're looking at, is OK, the odds of a recession. So as if they remain longer for higher, at what level, what's the backdrop? What's that impact going to be on global growth? And then from the fixed income side, there's implications too because if energy is higher for longer and it starts seeping throughout everything that, you know, the commodity touches with inflation, that it's proven sticky at these levels. It's low now. Is there a risk that it starts trending a little bit higher from these levels? And what implications will that have on fixed income?

Macan Nia: So from the conflict perspective, Kev, that's the way I'm looking at it, is oil. What's the new paradigm for oil and what's the implications for the global economy? You're currently there was the interesting as perhaps a transportation tax or transit tax for the Strait of Hormuz or some type of payment system to allow for safe passage.

Kevin Headland: And as you said, the, the next premium oil price is, is there going to be a, a constant kind of uncertainty premium, shall we say, which is embedded? But not only that, structurally as well, there's a lot of production that has been impaired, perhaps firmly impaired or at least long term impaired that'll take a while to get back into the system.

Macan Nia: So when you look at supply-demand dynamics of oil prices alone, you're already going to expect structurally higher oil prices. So the expectation that we go back to $50–$60 per barrel of WTI is probably way behind us and likely not to be seen for quite some time. So we should expect that. And I think, you know, when we look at this, it's quite interesting how, coming into this year, we talked about the expectation for more volatility or choppiness or uncertainty. The markets were now, quote-unquote, priced for perfection. We didn't know what that catalyst would be to create some uncertainty, but clearly, this is one of the key catalysts that has created this uncertainty.

Macan Nia: And while volatility, depending on the day, hasn't been extremely, you know, the markets are—you know, we're not talking bear market territory here—but I looked at the number of days of ±1% moves in the S&P 500 since the conflict began, and we're looking at about 25 trading days, and nine of those days have finished either ±1%. We had six down 1% days and three up. Prior to that, to get nine days total of ±1% closes on the S&P 500, you have to go back to the end of November. So it took three months to get that number of choppiness or number of ±1% days, and now we're seeing it in less than a month essentially of trading days. So that chop and that uncertainty is really happening.

Macan Nia: You even get the intraday choppiness, you know, the days where it opens down and finishes up or vice versa. Intraday choppiness is kind of an interesting thing you can track. It's not perfect, but there's been a lot of people looking at the weeks and saying how it opens. The S&P 500 has typically opened positive on Mondays and closed weaker to end the week. And one of the things I was thinking of is perhaps the uncertainty of when the markets close on the weekend. The activity there is traders closing positions and staying out of the market, not knowing what's going to happen by Monday when they actually can resume trading activity.

Kevin Headland: Yeah. So the volatility has increased and that goes into our second topic in terms of the VIX.

Kevin Headland: So today, I think on April 7th, it's increased because of the uncertainty about what happens tomorrow. But we're not—we haven't flashed 30. I believe we flashed 30 twice intraday once, and then we closed, I think, one or two days, and it came right back down. You know what's interesting, Macan? I looked at the VIX, and I looked at it from a historical perspective. Over the past 20 years—and not to talk about what we've talked about before, if you invest when the VIX is at certain levels—but I was interested to see how often do we get above 30, right? It doesn't happen too often. Over the last 20 years, there's been roughly nine times that you've seen it since the Great Financial Crisis. They're typically short-lived.

Kevin Headland: A couple of examples where the VIX was clunky for months were 2011 and then 2021–2022. And above 40, Macan, is like peak fear, and there's really only been—I'm looking at it right now—so since over the last 20 years where you go peak 40 or over 40, Liberation Day 2024, COVID, the flash crash, the European financial crisis, and the Great Financial Crisis. And the big ones that had on record is pretty close. It's actually—I was looking at it—it's interesting to have the peak of the VIX during the Great Financial Crisis similar to the peak in the VIX during COVID, which hit 80. So it just shows you, you know, everything that's unfolding and the uncertainty. Markets haven't really—they've reacted, of course, we're near 30, but we're nowhere near the doom and gloom or the negativity that we saw during those two periods.

Kevin Headland: We haven't seen capitulation, which is on one side mostly scary. But you got to realize, OK, have we hit the bottom yet? Probably not, but it does seem, given the positive backdrop that we talked about previously—the global economy, manufacturing data, earnings data—the resilience there has kind of pushed almost more optimism to the investors. The buy-the-dip mentality, the every time there's a semblance of positive outcome towards a ceasefire negotiation or something, the markets tend to be reacting more positively than the opposite negative.

Macan Nia: So on one hand, you could say, yeah, it's great. The markets are leaning towards this. On the other hand, you know, if we do get escalations in this conflict, we could see more downside. But that resilience and that backdrop, on the other hand, for a—I hate to say a long-term investor—but even an investor with, you know, a few years of time horizon here, this is set up as an opportunity, right? When we look at—we talked about the VIX, we talked about the VIX when it hits 30, and it's an opportunity for even investors one year forward, two years forward with very strong returns upwards of 15% annualized returns for two years.

Macan Nia: But valuation was called stretched, called elevated, whatever term you want to use. I would say it was expensive, but you've seen valuations across the board around the world on indices come down above a forward and trailing perspective. If those that were hesitant to be investing because valuations were elevated, does this now create an opportunity for those that want to take advantage of some of this uncertainty, some of this choppiness, to actually step into the market? Maybe dollar-cost averaging strategies or some other way to get some money moving because they're sitting on the sidelines waiting for an opportunity to get in. And here's the opportunity. It might not be the opportunity they're looking for, but it could be an opportunity.

Macan Nia: And I sense too—we've been talking about it, Kev, with our travels over the last couple of weeks, speaking with clients—and you're seeing this in the headlines as well—is people or investors are trying to draw similarities between today and back in 2022. There are some elements that feel the same. So back in 2022, similar to geopolitics right around the conflict in Russia between Russia and Ukraine, geopolitical tensions pushed up oil prices, and, you know, the backdrop created uncertainty into the outlook. And it also, during that period, kind of like today with those concerns, is, you know, growth is slowing. We're not anywhere near recession territory, but below-trend growth. Inflation isn't increasing, but it's sticky, and, you know, leading indicators, whether it's input prices for manufacturers, they've inflected upwards, so there's concern about inflation, you know, maybe trending slightly higher. And they're drawing similarities to that now.

Kevin Headland: Back then, in 2022, oil prices increased 100%. As you know, Macan, the difference was it was over a year. Like, it was gradual. Yeah, towards the end of it, it spiked up, but it was gradual. Whereas today, we've gone from, let's just say for round numbers, $60, and when we're speaking, it's north of $100, but it's overnight. So what impact? So that's going to be different in that sense. But oil prices have increased, and there's similarities. But as you've pointed out, there's differences too.

Macan Nia: Yeah, there was clearly a shock to oil prices during the initial invasion of Ukraine by the Russian forces. So there was that big shock. But last time, or in 2022, what you saw was the period where you're starting. So the key issue that created market uncertainty in 2022 was inflation and rising rates. When interest rates go higher, they affect both bonds and equities because bonds' interest rates go higher, prices go down. With equities, especially when you look at the S&P 500, which is typically more of a growthier market, should we say, and the top holdings back then were growthier companies, you know, like the Magnificent Seven and whatnot. Their valuation is based on interest rates because they use discount cash flow models, and that future earnings are discounted by interest rate. The higher the interest rate is, then the lower the earnings are worth going forward, which affords a lower valuation going forward.

Macan Nia: So we had a big jump in interest rates. You had the Federal Reserve at the time at 0.25%. That was the overnight rate as they had brought it down during COVID. The 10-year U.S. Treasury was sitting at 1.5% roughly to start the year in 2022. Federal Reserve rate hikes happened during that year. They ended roughly 3.5% at the end of 2022, and the 10-year Treasury finished the year roughly 3%. So it doubled. So that was a big move higher in interest rates.

Macan Nia: And one of the differences was—and I try to frame this as, call it, the three Cs of inflation. So when we talk about inflation, inflation has a year-over-year metric. So when we think about COVID 2020 to 2021, and 2021—call it March 2021—would have been the first kind of year-over-year price spike for COVID. Then go through to March 2022, you would see that initial spike up in prices, and the measure of inflation started to roll over because prices weren't moving higher. They were stabilizing at a higher level. So inflation was increasing, but you had now the conflict inflation. So the rise in oil prices and rising food prices kept inflation sticking at that, call it, 8% level nearer for the U.S. CPI. Then roll forward to March 2023, just as that next year of inflation pressure would have been rolling over and abating, you had consumption inflation because the WHO announced that COVID was over, and people started leaving their houses and consuming more, spending, pent-up spending, pent-up demand, excess savings. We saw it all. It was, you know, not just services, but another aspect. So we kind of had three years of sticky inflation, much higher levels.

Macan Nia: So you had this inflation level where we're not at the same level here. You know, we start off with federal funds rates at 3.75% today, not 0.25%. The 10-year Treasury is, you know, depending on the time, call it 4.2–4.25%. And the Federal Reserve has a bias to cuts, not hikes, because they're not, you know, caught behind the curve from COVID to hike rates or over-easy territory. And the key is you have that cushion of support in terms of interest rates for fixed income. So bonds, when you have very low yields, it doesn't take much to put you in the negative. When yields are starting from a higher place, the risk of having negative returns is so small now.

Macan Nia: One of the things that investors are looking at is the day-to-day, week-to-week, even month-to-month price movements on their funds or their investments. What they're not factoring in is income. Income is paid on bonds over the year, usually quarterly. So you're getting a price fluctuation, but you're not going to benefit from that income for your overall return calculation. I think more so right now, patience is important. We don't see the similarities. We see the similarities in 2022, but the conditions and where we're starting are very different for both equities and fixed-income investors.

Kevin Headland: Yeah, definite backdrop. But a key factor to watch is going to be the price of oil—how high and how sustained, right? If we're going into fall or winter of this year and oil prices are even higher and there's no resolution, then it's a different game. But as of right now, what we know is this is the situation, and there are buffers today that may have not been around in 2022.

Macan Nia: So I think the next two topics, Kev, I think they link to each other. So one is valuations. And the last we're going to finish off with private credit. And this was surprising to me in terms of valuations. We know they've come down, but specifically what has surprised me is how much tech valuations have decreased. I know they've decreased given the sell-off, but the magnitude. So NASDAQ, for example, the forward PE premium over the S&P 500 is just essentially 4.5%. The smallest spread since 2019. And most recently, so in October of last year, it was, round numbers, 36%. So that relative premium now, one could maybe say, 'Hey, tech is cheap relative to the S&P 500 based on the recent history.' And it's interesting to break it down. When you look at tech, who's driven it more? So big baskets—we're not going to get into the minutia—but three sectors, let's say subsectors. So one is semis, like the semiconductors, you have the tech hardware, and then you have software services.

Macan Nia: So early last year, right, AI boom, things were going great. On average, their multiples would have been in the 20 to 25 range. And then by the end of October, they had risen depending on the three, but they ranged from 30 times to 50 times. 50 times were the semis, right? NVIDIA, those of the world. And then the AI narrative in terms of the investment and whether they're what, that's how it flows with the credit. We'll go into that next. But there's the thesis. There's a little crack in it. And they sold off, right? Earnings sold in terms of expectations, sold off to where we are today where, for example, the semis are back down to their valuation that they were last year. So 20 times this, they went for a ride from 20 times to 45 times, back down to 20, and the rest have similar patterns.

Macan Nia: So the valuation that you're seeing, taking advantage of opportunities—everything's being thrown out with the bathwater right now. There are clearly going to be these companies that were attractive because of fundamentals, got bid up, and then maybe from a valuation perspective became less attractive. Well, now the market is offering you that same company at a cheaper valuation. Could it go cheaper? Of course, we don't know what's going to evolve or unfold in the Middle East, but it may be a good price point for those investors that are looking to get into these quality names at a cheaper price than what they could have over the last year or so.

Kevin Headland: I think it also speaks to the point last year and probably the last three years, there's been a lot of momentum trading that you kind of just chase after anything. It's going up. It's in a certain industry, we're chasing those stock prices up and the valuations up. And now maybe it's the opposite, right? Chasing things down. But as you said, the peripheral baby thrown in the bathwater is important here, where there will be winners out of these different sectors and different industries. It's about identifying the best companies. It's not necessarily about investing in all the companies or all the businesses, but finding the best ones and trying to figure out what the winners are.

Kevin Headland: And I still find it a little bit interesting, perhaps funny, that the big sell-off in software started because of a literature that was circulated. Oh, right. That was—it was essentially—it was quite—it was quite... Tuesday. It was a piece of fiction, but it was, 'Let's go to 2028 and AI has changed everything.' 2028 is actually not that far away when you think about it. We're almost a year and a half away right now, which is unreal. But could things change that fast? Possibly. But then also, I was listening to a podcast recently, and they were talking to someone about AI, and especially when it comes to software. Could it replace—could AI replace certain software? Yes. But how quick would companies be—major big companies—to change to unproven AI technology to replace software that they find proven just because it's a cost cut? It might not even be that much of an overall cost savings, but would they be that quick to move it? It'll be interesting to see. But there's been a lot of opportunity there, and just to take advantage of some of this valuation change.

Macan Nia: And interesting enough, when we look at valuation price of condos, we look at price-to-earnings ratios, price over earnings, just a fraction. I love it. My kids are all in fractions right now in math, so I really love fractions. It’s my math nerding. Wow. I love fractions. I don’t think I’ve ever heard anyone say that. Numerator, denominators, come on. So the P, the numerator, is coming down, but the denominator, the E, is actually moving higher during this kind of, you know, last few months, which is kind of interesting where they’re pricing in more earnings across the board—not just in the US, not just tech, but across the board for the next 12 months. So that’s kind of interesting as well, which has kind of played out. I’m getting maybe better earnings for a cheaper price. You’re just benefiting on both sides if you, again, have the forward thinking and the patience to be invested over the next few years. And the market is trying to navigate this environment of what the future looks like. And you’re seeing it within these sub-sectors as a performance. So hardware has actually held up relative to, you know, those sectors or sub-sectors where there’s uncertainty around how AI will impact, and to your point, the adoption rates.

Kevin Headland: I think why this story is interesting is that it naturally flows into the private credit discussion. Everything is linked. Everything seems to be linked, absolutely. And the private credit is—if it wasn’t for what was unfolding in the Middle East, this would be what already is on the front page, but it would be garnering more of investors’ attention. And Macan, when I’ve been trying to think about this, the way I can just summarize it is: Why? OK, basically, there’s this great skepticism in terms of how much accretive returns from AI can basically be garnered from investing, right? So people ask, how quickly can these tech companies monetize their AI investments? And as usual, investors always take a rosy lens. And now there’s been some skepticism in terms of the return profile. And as a result, that has linkages to private credit. It’s prompted credit concerns because a lot of the financing is provided by the private credit space.

Kevin Headland: And just to give you an example, Macan, I think it was the last couple of weeks of 2025, Alphabet, Oracle, and Meta sold $70 billion worth of bonds over the course of a couple of weeks to fund this. You know, we travel all over the place. We were joking about it. I went to Louisiana last week for a client roadshow, and one of the wholesalers was telling me that Meta is, I think, in the process of building its largest data center in the state of Louisiana. And just to put it into perspective, this thing is 4,000,000 square feet. So that’s equivalent to 100 football fields. And Meta says that it’s like a $10 billion investment. It’s going to create 5,000 skilled trade jobs. So, you know, you often look past the skilled trades in terms of how many jobs that creates. So that’s one example.

Kevin Headland: And you know what, I’ll pass it to you after this, Macan. Goldman Sachs—so all these outflows, but Goldman Sachs actually just disclosed they actually had net inflows of 5% of shares into them in terms of their private credit funds. So like AI, the private credit space, there is going to be benefit, there’s going to be winners, and there’s going to be losers. It doesn’t mean that private credit doesn’t deserve the space, like an asset allocation within an asset allocation sleeve. We just have to have a little bit more due diligence in terms of what we’re owning.

Kevin Headland: Well, I think the key is there is, as you said, it's due diligence. It's more about your creation of asset mix. It's diversification, right? One of the reasons that investors went to private equity and private credit is the lack of correlation in 2022. But that's because the private assets were not being priced on a regular basis. The mark-to-market wasn't there. Now, when the headlines screamed that these funds are gated, being or essentially closing or limiting redemptions, it's not to say the underlying assets aren't good or fine and a going concern. What happens though is when there's demand for liquidity in cash and investors try to pull their money out, it's essentially a run on the banks. It's like back in the day where people were trying to get their money out of banks, and the banks were saying, 'Well, no, your money's not here. It's invested in other things,' right? A bank takes money in and then uses it to lend out to other individuals. That's exactly what private credit and private equity are like. The money is not just liquid. If you are forced redeemers, you're essentially creating more disservice. You saw the same with Silicon Valley Bank, right, where their assets were backed by U.S. Treasury bonds. But because of the reduction in price on those bonds, when individuals went for all the money, they had to sell at a loss. So if you can control some of the flow of money for these private assets, which are supposed to be long-term investment vehicles, this is not a liquidity vehicle. So I think that's where it's important to realize that investors could benefit by holding these types of assets, but make sure that if you're using it as a broad portfolio allocation or as a piece of a piece of asset allocation, you have public assets for liquidity as well, right? It's a whole construction portfolio, and that's going to be the key over the longer term. And I think that's one of the issues right now we're seeing is we have this demand for liquidity. And that's not what this product should be, and that's one of the problems we're having.

Macan Nia: So I think that's a great place to end. I think we're running out of time. So I want to thank you very much for listening. For those who have enjoyed our podcast, please share it with other like-minded individuals. Please rate us on different podcast players. It helps other people try and find us. So if you are enjoying it, please again share it with your friends and family. And I think that hopefully you can put us on in the background and at least learn one thing. So once again, for Investors Unplugged, I'm Kevin Headland and my colleague Macan Nia. Thanks for joining and thanks for listening, and we will see you and, or at least talk to you soon. Have a great one. Enjoy.

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