Oil in the crosshairs

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Hello and welcome. My name is Eric Lascelles. I'm the chief economist and head of investment strategy research for RBC Global Asset Management. I’m very pleased to share with you our latest monthly Economic Webcast for the month of April. And the title is Oil in the crosshairs. So of course, referring to the fact that oil prices have increased quite remarkably over the last month or so as a part of this war in Iran.

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The focus of this presentation will certainly speak to that issue alongside some other developments and themes as well. Let's jump in and start, as we often do, with a report card of sorts.

Report card: I'll begin on the negative side of things this time. And so let's acknowledge, as we just discussed, that the war with Iran continues – at least as I'm recording this on April 1st, and there's no joking associated with that.

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That just happens to be the date. And so that war continues. Oil prices have increased, rather substantially over the last month. Our last webcast was right at the beginning of this war, and we already spoke to some extent on the subject. But prices are up further yet, and you might loosely say, in the low triple digits as it stands right now.

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Much of the concern around that is, of course, the Strait of Hormuz, through which quite a large fraction of the world's oil and liquid natural gases would normally flow. It is significantly blocked. And to put on my economist’s hat for a moment, there is therefore the threat to inflation going higher. The threat to economic growth going somewhat lower.

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We have seen a substantial financial market recoil. Of course, all of that is concerning and we'll talk our way through that.

And then just to acknowledge that we should be thinking, of course, about more than just one particular, albeit pressing issue. We'll talk a little bit about artificial intelligence again, which is such an important theme right now.

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Of course, there do continue to be some worries around artificial intelligence to the extent it is displacing certain sectors and eroding their moat, and perhaps it could also displace an increasing number of workers. So we'll talk through some of that as well. But there are real concerns there too.

On the positive side of the ledger now – and again, focusing in on oil to begin with – it's very important to recognize, we think, that this oil shock should be temporary.

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So this is not a forever thing. Past oil shocks have proven themselves to be temporary. We're not convinced this needs to last more than a few months. Indeed, there have even been some positive signs in the last 24 hours as I record this. Though I don't want to overstate those, I can say that it's really useful to remember that, compared to, say, the 1970s – though also arguably, quite truthfully the oil shock that occurred in 2008 – we can say that the world is much less exposed to oil prices. The economy is less geared toward it. The service sector is bigger and so on.

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In a way, that means that the pain associated with this should be less than it was during prior oil shocks.

I do want to remind people that economic data remains decent. We’re not seeing particular distress right now. That's including variables like weekly jobless claims, which are very much reflective of several weeks into this war.

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So not seeing too much pain there.

And then from a market perspective – of course, this is the glass half full perspective – but stock and bond valuations have improved. Of course, we've seen a retreat in stocks. We've seen bond yields go up. As a result, of course, there are opportunities for those thinking of getting into those markets.

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And then lastly, on the interesting side of things, let’s go back to AI for a moment. It’s very important to continue to acknowledge there are quite a number of ways it could go in terms of dystopian scenarios and utopian scenarios and a variety of other, more middling considerations. Actually, in our last webcast, we talked through several of these. I guess the punchline is we think the most likely outcome is this is a major general-purpose technology that is quite significant and quite a material driver of productivity and does displace some workers.

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But ultimately it doesn't necessarily increase the structural unemployment rate. If it does end up being something different than that and perhaps more disruptive to the labour market, I wouldn't want to underestimate the government's ability to tax ‘compute,’ as you might call it, and to some extent limit the damage and raise funds to retrain workers and so on.

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Not to suggest that all is perfectly well, but nevertheless there are a number of ways this could go. Some are actually fairly constructive.

We'll also talk for a moment about trade deals. The USMCA trade deal is up for renewal in the relatively near future. We'll just talk loosely about some scenarios that exist there.

We’ll acknowledge as well that the American midterm elections are sneaking a little bit closer to us now.

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I believe we're seven months out at this juncture. The polls have been shifting – in part, we think, because of the war in Iran.

Okay, so that's the plan. Let's just jump our way in now and start talking with the support of some graphics. And so just to start with a big, broad comment, it does appear to be a dangerous world.

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It’s a dangerous world: You can see this geopolitical risk index has spiked higher on the far-right side, reflecting the war in Iran. I can say that even looking over the span of the last several years, there have been, of course, several other spikes, with the war in Ukraine and so on. But in general, you would say even the relative lulls between those spikes are higher than we're used to seeing over the prior 20 or so years.

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And so this is a more dangerous world. It fits into this power-based order we've talked about. It certainly helps to explain rising military spending and so on. And of course, this war in Iran is central to it all. So let's dig right into that.

War with Iran: This is me doing what I do best, which is putting far too many words on the page.

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So I'll apologize for that in advance. And this isn't the last slide that's going to do that, I'm afraid to say, but it's a helpful guidepost for me, at least, as I speak through some of the big thoughts here. With regard to this war, with the U.S. and Israel at war with Iran, it’s more intense than the June 2025 surgical strikes that took place at that date.

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We've seen Iran retaliate fiercely itself. This is something of an existential threat. And so we're seeing all efforts made and Iran targeting not just military targets, but also civilian infrastructure and energy infrastructure of other Gulf countries that are theoretically neutral, though some do have American bases in them. The central debate is one of timeline. I'll speak in more detail a little bit later to that.

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But is this going to be a short, meaning only lasting a couple of months? Or is it extended, lasting many months? That would be the way of thinking about that.

My sympathies are towards the shorter side, but certainly it could be either. And I'll speak more to that in a moment. At this juncture, despite the U.S. and perhaps Israel aspiring to this, it doesn't look as though regime change itself is all that likely in Iran.

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A theocratic state still likely persists coming out of this. I will say Iran's nuclear ambitions have been knocked back significantly. Its military capabilities more generally, also hit. And so, from all those perspectives, certainly some changes are the result. But ultimately it’s still a rather intense war that continues and with a lot of uncertainty over timing and of course, with big implications for the price of oil.

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The Strait of Hormuz, as mentioned a moment ago, is the pinch point through which so much of the Middle Eastern oil and natural gas liquids would normally transit. Because those are not transiting at a normal rate, we've seen such a large increase in oil prices and natural gas prices as well. And as much as there has been a partial offset – and I'll show you a chart on that later –

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We're seeing the world ‘scrounge up your quarters from the couch’ sort of thing. Countries are finding other places where they can increase oil production or tap into reserves that exist or use other conduits through which the oil can pass.

Ultimately, there is a significant shortfall, which in turn explains the higher energy prices. From an economic standpoint, the global economy is moderately hurt by this.

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I'll share some numbers in a moment that show it's not a surefire recession or anything like that, but it's a real hit for many countries. We'll talk about the inflation side as well. Inflation should be temporarily higher. In fact, we can go beyond saying ‘should be.’ We're actually seeing now the numbers starting to pick up on schedule, essentially.

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It is more painful for Asia and Europe than it is for North America. They are the direct consumers of this product normally. We've seen bigger price increases, particularly for natural gas, in those regions, relative to North America. And, you know, from a central banking perspective, the debate really is ‘Do they hike rates because of extra inflation?’

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Do they cut rates because the economy is weak? The theory would say you cut, but that might be a little bit naive. Markets were thinking they hike but are backing away from that a little bit now. I would say I think markets have priced in perhaps a bit too much hiking, maybe outside of a country like Canada where actually perhaps the economy goes a bit faster due to the higher oil prices. That sort of aligns the incentives on one side.

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But even that would presume that oil prices stay high for an extended period of time, which is not certain. This is, we think, inherently a temporary shock. And now markets, of course, have responded in a fairly substantial way and bond yields have gone up as mentioned. So focusing on the inflation side, focusing on what they think central banks might be forced to do . . .

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Clearly it’s not great for the stock market both in the context of risk assets in general, but also, of course, airlines quite exposed and trucking/transportation substantially exposed, and consumer products and industrial products as well. Energy, of course, that sector likes this. And just remembering again, the temporary element of this is that when you look at past historical acts of war – and we shared a slide on this last month – you’d be really surprised by how small the decline off it is, how short-lived the decline off it is, how briskly the market can rebound afterwards.

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That's worth keeping in mind. It’s also worth looking at past oil shocks. And we've done this recently and I have a chart on this a little bit later. It makes a similar sort of conclusion, which is, yes, the market should go down, but it's not a forever story – and it's maybe less of a decline than you might normally think.

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I think the concession you might want to make, though, is in this seemingly dangerous world, in a power-based order and so on, perhaps some larger geopolitical risk premium that endures does make sense. So whether that means a slightly wider credit spread or a slightly lower stock market valuation or a slightly stronger dollar, all else equal, we think that dollar can fall over the span of years. But maybe it deserves to be a bit stronger along the way as it's doing that, if that makes any sense.

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That does make sense, that a bigger geopolitical risk premium might persist.

Okay. Let's keep pushing forward here. Really some pictures now to support all those claims I just made.

One-fifth of global oil and LNG supply typically transits through the Strait of Hormuz: First of all, here are the ships transiting the Strait of Hormuz. And so you can see quite normally there would be a very high level. And that level is virtually nothing.

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It isn't actually quite nothing. The chart makes it look that way. It's not quite nothing. We do see ships carrying Iranian oil and energy still at least partially transiting. And that's one of the offsets why oil prices haven't gone up even further. But nevertheless, this is a daily index we're watching very carefully.

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If we start to see this nudging a little bit higher, that would, of course, be a very positive sign.

Oil prices have spiked: Now, the price of oil itself, of course, is in focus. Just to make life complicated, we've added five different metrics. You would normally be talking about West Texas Intermediate, in dark blue, you might say North American oil, certainly U.S. oil. Brent is more generally thought of as a European or even a rest-of-world type of concept. Of course, in this context, we can also talk about very specific Middle Eastern oil metrics.

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And there's a Dubai price, an Oman price and a Murban price. And they've been moving around more and actually some, the Oman price in particular, went much higher. And so that was a talking point for a while. It looks to us as though it wasn't actually the case that the price of oil was necessarily rising that much in that region, in an enduring necessary way.

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It probably had more to do with speculators who were pushing that up on the view that there could be further increases. And this would be the closest market to which you could place that wager.

We've seen them converge to some extent. So maybe the real point here isn't that there are five different metrics.

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The real point is they're all a lot higher than they were back in February. And you are talking whether it's a $95 oil or $110 oil or something in that range, depending on the metric. That's about where we are. And of course, there's real damage that comes from that.

Likelihood that oil prices keep rising if conflict stretches longer: And just to acknowledge, to the extent the war were to continue – and again, there have been some maybe positive comments in recent days, but it's ebbed and flowed.

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We shouldn't be too confident about that. You can say that normally you see oil prices rising the longer such shocks persist. Essentially, as inventory levels are diminished around the world, as countries tap their existing reserves, you do tend to see the price of oil sneak higher. And so if this thing were to last another month or another several months, you could imagine prices not necessarily staying at $100 a barrel, but moving up somewhat further along the way.

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Oil market assuming longer conflict, slower post-war normalization: A loosely similar story here. Or maybe the angle here would be – and this is the oil futures market – those different lines really reflect the market becoming less optimistic over the last month. And so the lines sort of shifted up and up and up. The latest contract from March 30th is the highest line.

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This is to say that the oil market has had to consistently, repeatedly revise its assumptions about what a normal oil price is. It still thinks that the conflict will ebb over time. It still thinks oil prices can come down over time. But the reality is, it's not such a happy place as a starting point right now.

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It’s worse than it was a few weeks ago. And the market's even assuming that oil prices come down a bit less quickly as well. And it won't be an automatic thing because it will take time to get production going again. Some of these facilities, some have been damaged as well by drones or by missiles. Similarly, you'll then need ships to be where they need to be.

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And the ships will then need to transit the energy to its destination. All of that takes time. And so you can see just how the market is assuming it's a couple of months to get oil prices significantly down – and then even when they're significantly down, there's this assumption that oil might be a $75 or $80 product for a more extended period of time. Not the happy $60 a barrel that it was just a month or two ago.

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Strait of Hormuz also pinches non-oil shipments: Let's acknowledge that as much as the focus tends to be on oil – and just a fraction of critically seaborne trade in these products occurs through the Strait of Hormuz. So there on the far left, crude oil is a big, big chunk. We hear 20% of the world's oil supply, but that's an approximation.

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And the reason this is almost twice that at 38% is that it’s the seaborne fraction. Not all the oil is traveling across the ocean. You've got pipelines in North America and elsewhere. So a big fraction of seaborne oil, a big fraction of liquid natural gas and related natural gas liquids are here. But other things too, right.

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As you look to the far right, at the three bars there, it's a significant or at least non-trivial fraction of chemicals. And a very significant share of fertilizer. Helium has been in focus a number of times – and you might think helium is for birthday parties, and it is, but it's also actually quite critical to computer chips and things like that.

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So there are some knock-on consequences there. Just containers meaning and maybe just reflecting the fact that, of course, the countries within the Middle East are importing products from the rest of the world. And so those are crimped as well and then dry bulk as well. Ultimately, maybe the point here is a lot of different energy products are key.

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Also some very important chemical products that you might not have thought much about.

Okay. So how soon does this war end? That sort of is the debate right now. And as soon as you can get this thing over, oil prices can start, you would think, to settle back down.

Market-assigned likelihood of early war resolution has declined: So this is betting markets betting on different dates.

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For instance, that cluster of bars on the far left was the likelihood that the war would be over by March 31st. So that's yesterday as I'm recording this. Of course it didn't happen. Technically these are probabilities from two days ago, if you wonder why it wasn't a 0% chance on that.

Most recently, you can see at one point the market initially said, well, maybe there's a 44% chance this war is done by the end of March.

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And then it downgraded that number to 33% and then into the teens and ultimately it didn't happen.

April 30th is next in focus, the next big month end date in focus. How likely is it that the war is done by then? You can see there's been a significant decline in the betting markets assigning a probability to that as well.

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At one point that was thought to be a 67% chance. Then it was 30%. I didn't check it as I was walking in here, but I'm guessing that's gone up a bit, actually, given just some recent news. Nevertheless, you're not certain. It’s possible.

And then you sort of ship further out into May and into June, and sometimes those markets haven't consistently existed.

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So sorry for the inconsistent bars there. But the market is saying, well, there’s a decent chance this is over by the end of May. And a pretty good chance it’s over by the end of June. So the central tendency is to think it's a three-month conflict right now.

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I will take the under. I might be wrong in that, certainly, but I would say I think the risk is this ends sooner as opposed to later. But there are real risks on both sides of that statement.

Let's talk about those risks.

Iran war debate: Here's the other wordy graphic. So apologies again, let's just talk it through.

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I wanted to have this here just in case somebody wanted to press pause and sort of think a little more themselves about some of these things. So if you want to be a pessimist and you say this war is going to last longer or it's going to have a worse outcome, you would focus on the left side. If they could end sooner and better and so on, maybe focus on the right side.

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I'm going to work through both. We'll start with the negative arguments. One would be just that Iran is proving quite formidable or indomitable, you might say, and refusing to be defeated here – despite, just on paper, being overwhelmingly outmuscled.

Iran feels it faces an existential threat and the regime is threatened.

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And so it is acting with real, sustained aggression and doing everything it can. Iranian drones are relatively cheap, relatively plentiful, relatively easily launched compared to a missile. That is proving – and it's true in Ukraine as well – that is proving to be the game changer in this new technology for new wars. And so Iran is reasonably well positioned for that.

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And that is seemingly what has allowed them to continue striking the rest of the Gulf, even as many of their more traditional missile silos and launchers and so on have been destroyed. Perhaps they can continue on that front. But it should be noted, the drones seem to, in general, do significantly less damage than a traditional missile might.

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There is an asymmetry here. So the asymmetry is Iran doesn't need to hit every tanker that tries to transit the Strait of Hormuz. They only need to hit, say, one in 50 to create a big problem where ships can't practically go through. And so that's their measure of success. And that's not an impossible measure.

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So that's concerning. Certainly, we've seen real damage to Gulf civilian and energy infrastructure. And I would still say we're of the general view that there's room for production, nevertheless, to increase significantly as soon as the transportation issues are resolved.

But some element of this is going to take longer. And there was one Qatari facility in particular where I suppose a full normalization could take three to five years.

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So, you know, the fear here is we are debating does the war end in two months or in four months? Maybe the real debate is could the energy infrastructure be destroyed to the extent that there's no there's no quick resolution? And this is an enduring energy shock, which would be a much bigger problem.

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I don't think so. But there has been some damage done.

There’s also scope for Iran expanding this war. We learned, to everyone's surprise, that Iranian missiles can potentially reach Europe. They traveled, I believe, 4,000km. They went towards the Indian Ocean. But, in theory, they can go in other directions as well.

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And so there's a risk of escalation or expansion there, too.

So, that's the Iran side. Meanwhile, on the U.S. side, you can levy a few critiques if you want to be negative. You can say the U.S. doesn't really have a particularly clear objective – or it's thrown out so many different objectives and not all of them seem completely realistic.

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The U.S. constructed the attack plan fairly hastily and without clear objectives it’s hard to have a good plan. They didn't get buy-in from allies other than Israel. There have not been others taking part in this. And so that's a limitation as well.

And then, there's been talk of intensification. I'm going to speak to that in a constructive way in a moment.

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But there's a negative side to this too, which is if the U.S. were to pursue boots on the ground. Of course, they have assembled a significant number of Marines in the Middle East now. That could well lead to a more overwhelming victory at a later date. But it could also extend the war in terms of just being a very time-consuming pursuit.

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Similarly, regime change objectives would extend the conflict as well. That's been discussed as something the U.S. would like to achieve. It looks like a long shot at this juncture. If the U.S. is stubborn about that, that could take a long time to do and then a long time to stabilize. And we've seen how things played out in Iraq and Afghanistan. It is very difficult to sustain as well.

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So, if those end up taking place, it could take longer. And similarly – and I mentioned this before – even if the war ends today, it takes weeks to months to fully restore energy production, oil supply and shipments and so on. So, there's a lag there as well. So that's the bad news. So if you want to be a pessimist, that's what you should be focusing on.

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And it certainly needs to be evaluated by everyone. The arguments that it could end sooner could have a less problematic outcome, which I am personally maybe a little bit more sympathetic to, though I'm nervous about those other ones.

First of all, don't underestimate how much the world wants this to be fixed. The U.S. is very keen to get this solved.

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Polling is suggesting that the Republicans are suffering and may do poorly in the midterms as a result of this. Pocketbook economics are central and the price of gas has gone up, but mortgage rates have gone up and so on, due to this war. And so the U.S. is very keen to get it resolved. We've heard the White House now saying various things to that effect.

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Don't underestimate the extent to which China wants this resolved. The largest single consumer of the energy products that flow through the Strait of Hormuz is China. And so that's important. Asia cares a lot as well. Europe cares a lot as well, particularly on the natural gas side. Gulf states obviously are not pleased they can't sell their energy product.

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They're also seeing their low-tax sort of urban hub business models are challenged at the same time. And so they're very keen for a solution as well.

A ceasefire could happen rapidly, right? This is not a classic military victory. It could happen almost instantly. And so the U.S. has proposed a plan.

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Iran has issued a counterproposal. They're not that close together. They've said things that are not particularly kind to one another. But there is some talk happening. Pakistan is a mediator. There are semi-simple solutions in terms of Iran committing to end its nuclear ambitions and perhaps getting some sanction relief. It could be resolved quite quickly, possibly.

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There are very clear and direct diplomatic channels that China can take to Iran, that Saudi Arabia can take, that Gulf states can take. And so there are a number of ways this can be fixed. Pressure is being applied to a greater extent than you might imagine. The Iranian leadership is perhaps in personal danger.

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We've seen the various leaders killed. They are no doubt somewhat nervous about that and could be more inclined than you would think to strike a deal. Or the U.S. may just leave. And so there have been threats to that effect. I'm hearing less of that in recent days. But nevertheless, they could leave. And Gulf states could say, why are you attacking our energy?

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We didn't fight with you. And this could settle. It's a possibility. So, there's a number of ways, again, a cease fire could happen fairly quickly.

There is also this other way that you get to a resolution. There could just be an overwhelming military victory by the U.S. and Israel. And the U.S. is sending more troops.

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Saudi Arabia and Gulf states could join the war. They've said to be contemplating that as they're being targeted by Iran. And Iranian defense and offense are both being depleted. You know, its capacity to defend itself is greatly reduced. And many conventional estimates will say its missile arsenal, its drone arsenal has been significantly diminished.

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You can see a greatly reduced number of such strikes on Gulf states in recent weeks. So maybe they are just running out. And it's just hard to say with much clarity.

And then maybe the final angle, if you're thinking of a sooner resolution, would be more of a stopgap. The U.S. has talked about and there are some claims they are close to implementing shipping insurance that would add perhaps protection that would allow ships to transit even with a war continuing.

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And so that would of course reduce the price of oil without fully resolving the war. Of course, we're seeing alternative oil supplies pursued. Some of that might run dry over time if you're talking about reserves being tapped. Conversely, it does give more time for Russia to ramp up production.

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And that's one of the perhaps unseemly elements of this, which is Russian energy production is being given a waiver to produce more and sell more temporarily. And so there are some ways that you can continue to fill some of those holes.

Okay. Now some charts to support those claims.

White House motivated to find quick resolution: So this is, in fact, betting markets on who will win the Senate for the midterm elections in the U.S.

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And so you can see, for the longest time it looked like the Republicans in red were going to capture that. Really, as soon as the war started those numbers started to converge – and actually, as it stands right now, the Democrats are the slight favorite to win the Senate. They're already the favorite to win the House, which I didn't show here.

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So there's a scenario where you get a Democratic sweep in November. And that's not something the White House will feel very good about. And so they're highly incented to get this thing done and dusted and get oil prices and gas prices and mortgage rates back down.

Good news, as I mentioned earlier, from an economic standpoint, is just the intensity of the global economy towards oil.

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So how much oil is needed to generate one unit of economic output?

Fortunately, oil shocks are less problematic than in the 1970s (or even 2009): The main thrust here is just that there has been a 62% decline in that intensity. And so you should see 62% less damage, you might say, for the same oil shock compared to the 1970s. Not to say it's inconsequential and it's rather painful for many, but it's much, much less painful than it was in the 70s and even in the 2008/2009 oil shock.

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Nearly ¾ of oil shortfall can be temporarily offset elsewhere: When we talk about the loss of 20% of the world's oil and gas – loosely, it's actually about 20 million barrels. That's the bar in gold. Well, there are a lot of offsets, actually. About three quarters, not quite, but almost three quarters of the shortfall is temporarily being offset elsewhere.

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And so not to get into the weeds here, but there's a big East-West pipeline in Saudi Arabia that's actually able to process 4 million more barrels a day. So a fair amount is going that way. Some concern, now that the Houthis are perhaps engaging, as to whether that becomes compromised. But for the moment, that's working. The Emirates have a pipeline as well.

00:26:34:06 - 00:26:52:25

Iran is still selling a fraction of its normal oil. It's not bombing its own ships. The Organisation for Economic Co-operation and Development (OECD) is releasing 400 million barrels of oil over a period of days. So that is adding significant daily production. China has big reserves. They actually haven't released much yet, but they're in a position to do it.

00:26:52:25 - 00:27:10:11

We think they will as needed. Russia is producing more and selling more at least. And so actually, what looks like a 20-million-barrel-a-day shortfall is actually more of a 5.4-million-barrel shortfall, which actually explains why oil is around $100. If you were actually missing 20 million barrels, it would be more like $190 a barrel of oil.

00:27:10:11 - 00:27:30:27

That would be our estimate. So we're certainly glad that we're not there.

In terms of the economic implications that extend from this, here’s a bit of a busy chart.

Extended oil and natural gas shock still isn’t necessarily recessionary: So this is GDP and inflation impact by country. So the first set of bars, the zero was just that in theory the U.S. economy is actually neutral to high energy prices.

00:27:30:27 - 00:27:51:11

It's actually a significant energy exporter. It does see higher inflation though. That's plus 0.9. If you look at Europe and the UK, Japan and China, they are kind of more conventional. There's a blue bar pointing down, which means their economies are weaker because of this energy shock. Their inflation is notably higher. Asia and Europe are the most affected regions –

00:27:51:11 - 00:28:07:13

if you're wondering why those numbers are bigger than they are for the U.S. Finally, for Canada, in theory Canada is quite a significant oil and natural gas exporter. And so our modeling would suggest the Canadian economy should run a little bit faster, if anything.

00:28:07:13 - 00:28:31:00

Inflation is also higher. The reality is consumers are paying those higher prices here too – but the economy doesn't have to be hurt.

Now, this is a simplistic model. This pretends that oil is essentially $105 a barrel forever, which we think is unrealistic. It should come back down. So maybe less damage. It has natural gas prices up about 50% on average, more in Europe and Asia, less elsewhere. Again, probably not forever.

00:28:31:02 - 00:28:47:06

Similarly, though, also from a more negative standpoint, it doesn't factor in the fact that financial conditions have tightened a bit. It really just says if oil moves, here's what happens to the economy. We're simultaneously dealing with something of retreat in the stock market and higher yields, and some risk aversion that maybe does a bit more damage.

00:28:47:06 - 00:29:07:06

So there's some sort of push and pull here. But loosely speaking, those are the sorts of numbers we're dealing with. Focusing on the blue bars, notably this doesn't seem to us to be a full-on recessionary shock, necessarily. It's significant, if it were permanent. If it's temporary, it's even less likely to be a full-on recession or shock to our eyes.

00:29:07:08 - 00:29:21:29

Recession risk now rising again, though tame: Speaking of that, this is a U.S. recession model looking out over the next year. It's just our model. I'll show you something else right after that gives a slightly less favorable sense. But our model would say the risk of recession – if you squint your eyes and look to the far right side there – is about 12%.

00:29:22:01 - 00:29:39:19

And it was sitting at about 5% as of before the war. So the risk of recession has gone up notably, but it's still, this would say, fairly tame. Now, we've always thought, at least in recent months, this has been maybe a little bit too kind. And so probably the risk is somewhat higher than that. However, I would actually push back a little bit against this.

00:29:39:19 - 00:29:59:21

Betting markets express concerns about U.S. economy with sharp increase in recession risk: So this is another metric. This is a betting market. And they're proliferating as you're probably aware. And it says the risk of a U.S. recession in 2026 has gone up quite a bit, although recently falling a bit as we see perhaps scope for some resolution. But you can see there, the normal or at least the pre-war risk was thought to be 20-25%.

00:29:59:21 - 00:30:14:27

So quite a different starting point. Actually, like our model, it's roughly doubled. And so it went to as high as about 40%. It's now about 32%. We would say maybe the risk is a bit less than this. It's probably higher than our model, probably somewhere in the middle. Again, the risk has gone up.

00:30:14:29 - 00:30:33:08

But it's not a certainty. I think that would be the main point.

When we look at inflation, we do see the effects. For instance, European formal inflation has come out. We saw very clearly higher oil showing up in the numbers. We're still waiting on U.S. and Canadian official CPI prints, but this is real-time inflation.

00:30:33:10 - 00:30:53:23

Real-time inflation measures show effect of oil spike: PriceStats calculates this and publishes this. And you can see that blue line shows that indeed, as everyone would expect and as everyone is seeing at the pump right now, there’s a significant jump in inflation. So that is coming in the official numbers. It looks to be sort of loosely on the order of a percentage point jump on the left chart, which is a monthly change.

00:30:53:23 - 00:31:13:24

And, broadly speaking, it’s about a percentage point increase, as you might think, on the right side too. I would just say, if you think this is a forever oil shock, even with that the monthly change after April should then settle back down and be roughly flat – at a higher threshold of course. If you think it's temporary, there should actually be some months out there –

00:31:13:24 - 00:31:32:20

and whether it's next month or three months from now or something like that – where we actually see that blue line on the left side going significantly negative and unwinding that. Right. So we could see that reverse fairly substantially once the war is resolved.

Market-based inflation expectations shoot higher: In the meantime, it's very useful to look at inflation expectations. These are market-based inflation expectations.

00:31:32:20 - 00:31:50:05

And so three very different things on this chart, different time frames, you might say. That's what they are. So first of all, we can start with the darkest blue line. That's the two-year inflation expectation by the bond market in the U.S. That’s gone up notably. That makes sense because suddenly inflation is going to be, at least temporarily, call it a percentage point higher.

00:31:50:05 - 00:32:06:07

And so this looks to me like it's going to be gone up two-thirds of a percentage point or something like that. And so, I might argue, it's a bit too much of a move. Nevertheless, the expectation is prices, will prove to have been notably higher two years from at least a couple of months ago relative to where they were.

00:32:06:07 - 00:32:29:16

That makes sense. Interestingly, the lighter blue line is the five-year inflation expectation metric. It's off much less. That's a pretty strong statement. This is not a new era of high inflation. It's a one-time shock, if that makes sense. So less relevant over a longer time period.

The five-year five-year line, which is the gold line, actually looks at years six through ten in the future.

00:32:29:16 - 00:32:58:16

So it looks out five years and the next five years after that. That's what it's focusing on, year six through ten. First of all, it has not gone up. That is really the main point.

The second point is it looks pretty reasonably tame, but it's actually gone down, a little bit. So that would say, if the oil price is higher for a bit, that is actually bad for the economy and the market is thinking maybe there's a rate hike or two that has to happen. And maybe the economy is worse and inflation is therefore lower, further out.

00:32:58:16 - 00:33:15:18

So that's sort of the opposite implication. When we look at the economy, what's happening, again, it's early going and very much we should anticipate some damage from these higher oil prices. And they're just sort of bleeding their way in at the pump and presumably it discourages consumers a little bit. And then you see transportation costs for companies going up.

00:33:15:18 - 00:33:37:04

And it trickles its way in in different ways. So, it's premature to say no damage, of course.

U.S. jobless claims not showing any economic distress or major AI effect: But this is a weekly initial jobless claims figure for the U.S. It’s through March 21st, so it's encompassing the first full three weeks of the war. And we've seen not a single tick higher.

So, still looking quite tame and speaks to our view, at least, that the global economy is fairly resilient.

00:33:37:04 - 00:33:54:15

The North American economy in particular shouldn't be really too badly hurt by this, at all. And just a reminder, and this is not new, but just a reminder that we've been talking for a while and we still think this is important and will be back in focus once this war is over. That there are some real growth tailwinds for 2026.

00:33:54:15 - 00:34:13:09

Still some growth tailwinds for 2026: And so central banks have done real cutting in the last year and a half. That still trickles through to help the economy with a lag. Fiscal policy is very generous. It could even get more generous.

I'm sure the White House is tempted to do more fiscal stimulus as people pay more at the pump. Stock market is down, but it's still up a lot over the last year and over the last few years.

00:34:13:09 - 00:34:36:18

So there's still a positive wealth effect. We’re still getting for the U.S. a lot of artificial intelligence related CapEx.

We think we're starting to see some productivity pick-ups from AI. Bottom line is we think actually it still could be pretty good growth, though obscured temporarily by this war.

Checking in on tariff impact a year later: Let's check in on tariffs for a moment. It's been a good year since they really got cooking last spring.

00:34:36:20 - 00:34:54:22

And so this is colorful I guess, to be the starting point and a bit complicated, but we just wanted to go beyond ‘What's your average tariff rate? How important is U.S. demand to your economy? That's important, obviously. You can simplify this down to just a two- dimensional matrix.

00:34:54:24 - 00:35:11:24

But we wanted to look at more variables and really say, so who's been hurt the most by tariffs? The left half of this table is really the theoretical start side. And so how big a tariff rate is America paying on your products?

00:35:11:27 - 00:35:30:10

How exposed are you to that in terms of your trade with the U.S.? Did you manage to sign a deal? You might think, well, that doesn't matter – if the tariff level is high, what good is a deal? But actually it just creates certainty, removes uncertainty. Lets businesses do things with that certainty. So, the left half is really a theory of who should be hurt the most and who should be hurt the least.

00:35:30:10 - 00:35:49:09

The right side is sort of in practice that who is being hurt and who isn't. And the reality is, there often are slight differences between the two. Who's seen a notable drop in the market share of their sales to the U.S.? Who is successfully diverting their trade to other markets? Whose economy, as per purchasing manager indices, is weaker?

00:35:49:09 - 00:36:05:11

So all sorts of things. It's complicated. They all have a grand time disagreeing with each other. But on the far left you'll see the overall score, that orange box. Below it – and sorted from worst at the top to least bad at the bottom – are the countries that would seem to have been most adversely affected.

00:36:05:11 - 00:36:26:17

So, we have Brazil is number one. China, interestingly, is number two and then Malaysia, India, Mexico and Canada as well. And on down it goes in.

In contrast, you've got towards the bottom, the UK, which has done pretty well. Taiwan and Singapore and France, not too badly. Vietnam surprisingly well. Vietnam has a huge trade orientation to the U.S. and suffering large tariffs.

00:36:26:17 - 00:36:48:11

But it has such a dynamic economy and it's sort of been actually really eating some of China's lunch, sort of continuing to pick up some of the manufacturing there. It's actually done surprisingly well out of all of this.

So there's who's doing well and badly. Of course, Canada and Mexico are still waiting on their trade deal. That USMCA trade deal is due for renewal as of July 1st.

00:36:48:11 - 00:37:07:11

Still awaiting clarity for Canada: USMCA scenario probabilities: It's a little bit convoluted. You either get a deal or you start renewing every year from there for years and years. It's quite complicated. But I guess the main conclusion is, negotiations are seemingly active between Mexico and the U.S. They're a little bit more stagnant between Canada and the U.S. It doesn't seem like Canada is in a huge hurry.

00:37:07:13 - 00:37:25:02

We even try to think through when, realistically, will a trade deal be struck and what kind of trade deal might it be? And that's what these two axes on this table are. The debate is you get this done in 2026 versus 2027. And so we're a bit more sympathetic to 2027 if you kind of tally those up.

00:37:25:02 - 00:37:42:26

Technically, I think we can say there’s a 40% chance that a deal is struck this year. There’s a 60% chance it's next year or beyond.

The other debate – this is the y axis – is this a good deal, meaning tariffs go down? Is it an okay status quo deal, meaning it's more or less the same? Is it a bad deal, meaning that the tariff rate goes up significantly?

00:37:42:28 - 00:38:04:22

Again, it’s sort of messy and complicated. If you were to set aside the timing for a moment, I think we could say, with about a 40% chance, it's a good deal where tariff rates come down and you get those steel and aluminum quotas that were talked about last fall and so on. And you end up with a notably lower rate.

There's about a 40% chance on the net that it’s a status quo outcome.

00:38:04:22 - 00:38:24:11

And there's about a 20% chance it's a bad outcome, where the tariff rate ends up significantly higher and the USMCA exemption essentially goes away. You end up paying 10% on everything that that isn't already tariffed at a higher rate.

So you might be wondering, what is he saying? All these numbers 40, 60, 20 – I only see 16s and 24s on the chart. That's the interplay of the two.

00:38:24:11 - 00:38:53:06

So, the odds then, that it's a good deal and resolved in 2026 is 16% the odd it's a good deal and resolve next year or beyond is 24%. And you work your way down.

Unfortunately, there's nothing here that's 80%. This is absolutely what's happening. Lots of different ways this could go. I guess most useful is just to reiterate at this point, given the heel-dragging, given we're working our way through the year and so on, we actually think it's more likely it's a 2027 or beyond resolution as opposed to this year.

00:38:53:08 - 00:39:11:11

And we think to the extent a deal is struck, probably either a good deal or an okay deal, less likely that it's a bad, problematic deal. And one of the problems, I guess it's worth flagging if the negotiations extend on, is just uncertainty persists for longer. And so we thought that's holding back CapEx in Canada.

00:39:11:11 - 00:39:33:14

And when you get that certainty, whatever that is, that will be a time when you might see a notable upsurge in investing.

Okay. AI. We can't get too far from this:

AI improving at exponential pace – with rising return on investment: This chart might seem strange. I'm using this chart to justify the claim that AI is improving at an exponential pace. This is the performance of one AI model and then the next and the next all sort of moving up into the right.

00:39:33:17 - 00:39:50:12

I will admit this looks linear. However, for you math whizzes out there, you will note that the y axis is a logarithmic scale. So actually just a straight line here means there's exponential growth in the performance of AI models. That's what's being measured here.

And so we found ourselves sort of saying, well, hold on a moment.

00:39:50:15 - 00:40:06:24

We know AI is getting better. We didn't really know in our heads, though, whether it was getting 20% better from one year to the next or 1,000% better. It wasn't quite clear. For that matter, how do you measure that? It's actually quite hard to do and imperfect. So that's an important caveat.

00:40:06:26 - 00:40:23:29

What we found was there are experts who look at this, and METR is the source for this, and they are finding that there was exponential improvement, kind of quite astonishingly. And they're finding these models are getting I think it's six times better per year over the last several years.

00:40:23:29 - 00:40:43:26

They're improving with like a 600% improvement per year, which is quite remarkable. I guess the point there is real gains are happening.

Secondarily, you would say, well, how many computer chips or how much of your processing power do you need to achieve these improvements? How much compute? The compute has been going up about five times.

00:40:43:29 - 00:41:03:00

And the cost has been going up 3 to 4 times per year. So on one hand you say those are crazy numbers. Cost is going up 3 to 4 times a year. The amount of computation is quite five times. It's unbelievable.

But the output is getting six times better. And so as imperfect as these measures are, you could say actually that's a rising return on investment.

00:41:03:08 - 00:41:22:09

You're getting more out of every dollar you're spending, in terms of whatever this ability is on the far side, than you were a few years ago, per dollar spent. So, it helps to explain why those in the AI business are actually feeling quite optimistic and feeling pretty good about the strides they're making. There would appear to be very real strides and actually some efficiency gains along the way as well.

00:41:22:11 - 00:41:38:08

Okay, I’m going to finish with some market type stuff here.

Steeper yield curve: These are long-term bond yields across a variety of developed markets. And I think we're all broadly aware that long-term yields have been rising, if anything, over the last year and a third or so. And of course, that's in contrast to the fact that many of these central banks have been cutting rates.

00:41:38:08 - 00:41:56:27

And so it's very much a steeper yield curve. It's not a totally new phenomenon, but we've seen it actually play out even a little more over the last month. I think what you're seeing is that this market's a bit nervous and really more than that, just demanding compensation for what they perceive as fiscal excesses, big deficits and so on.

00:41:56:27 - 00:42:15:23

And you want to be paid a bit more if a country owes a lot of debt. Some inflation concerns, of course, are more recently surfacing, and just in general there’s greater volatility risk. And so it's this dangerous world and there's geopolitical risks over here and there's AI uncertainty over there. And here you are as an investor giving your money for 30 years to a government and hoping you get that back.

00:42:15:23 - 00:42:32:26

And it's very, very likely that you do. But ultimately you're demanding a little bit more compensation for that. So we see those longer-term yields going up. It makes sense to us that those longer-term yields are higher. It makes sense that the yield curves are steeper. We think that's sort of a feature or at least a constant in this new world that we are living in.

00:42:32:29 - 00:42:50:26

Rare for stock market to lose more than 10% during oil shock: I mentioned briefly earlier, cryptically, that we had done work on past oil shocks. I know this isn't saying necessarily a ton and it seems awfully jittery. We've looked at 15 past oil shocks just to get a sense of what the stock market does, the S&P 500. Certainly, it moves all over the place.

00:42:50:26 - 00:43:08:23

There's not as much directionality or precision as you might think, which maybe is half the story – because it suggests that it's not quite automatic that stock markets collapse when there's an oil shock. It's more mixed than that. When we focus in on supply-driven shocks, which if you look closely is the third item on the legend.

00:43:08:23 - 00:43:26:25

Anyhow, we find that the average supply driven oil shock – and this is one of those – sees about a 6% drop in the S&P 500.

Now, let the record show the stock market actually has gone down at its peak to trough so far more than that. So this is not a perfect gauge of anything. But it does help to give a bit of a flavor for that.

00:43:26:25 - 00:43:44:26

And I think equally relevant, at least, the median experience across all of these different ways of slicing oil shocks, is that you generally have a stock market that is significantly rebounding and in some cases quite quickly. Even with the more serious events, it’s often within the span of 120 trading days or so.

00:43:44:26 - 00:44:03:28

And so again, this is driving home the idea this is a temporary shock. Often there are opportunities that exist for investors in taking advantage of that.

Stock valuations have become more attractive: I'll finish with this, which is just stock valuations. We’ve framed the stock market globally in the past as one in which the earnings outlook is actually pretty good.

00:44:04:00 - 00:44:22:09

However, you are grappling with maybe less attractive stock valuations. And so that's been the challenge. Perhaps to no one's surprise, because we have seen stocks come down –what do you know? – their valuations are low. So if you are considering investing in the stock market, we find the valuation environment now to be somewhat better.

00:44:22:09 - 00:44:47:27

If you're talking about the global valuation which includes the U.S., it's that dark blue shaded area. It's hard to see the latest point. But it's only a little bit above theoretical fair value now – having been more notably above. If you look at the world ex-U.S. – and we think it's very interesting to look at ex-U.S. markets these days – the stock market looked maybe uninteresting at fair value and actually now looks a little bit cheap again.

00:44:47:27 - 00:45:04:01

And so certainly valuations are not a strong indicator of near-term market movements. It's more of ‘not the worst time to be putting money in over a long-term perspective,’ where valuations have improved in the last month.

Okay. I'll stop there. Hopefully you stuck with me. I guess you did, by definition. Thanks for your time.

00:45:04:01 - 00:45:17:03

I hope you found this useful and interesting. Please do follow us online if you're looking for more. There's our website and LinkedIn and a QR code as well, if that's useful. And I'll say again, thanks so much for your time and I wish you very well with your investing.