Investors are dangerously complacent about potential blowback from Iran conflict, former hedge-fund exec says

By Barbara Kollmeyer

Right now, nothing is priced in

U.S. investors aren't bracing for more blowback from the Iran conflict, which could become a problem in the weeks ahead.

Investors have been dangerously sanguine about the Iran conflict as oil prices rise, with U.S. stocks registering only moderate declines, warned a former executive at hedge-fund giant Bridgewater Associates.

"When you're trading markets from a macro perspective, you always have to keep in mind that you're trading relative to what's priced in. And so if I just look at what's priced in, nothing is priced in," Bob Elliott, chief investment officer at Unlimited Funds, a provider of exchange-traded funds, said in an interview on the "Excess Returns" podcast that published Wednesday.

Elliott, who headed up Bridgewater founder Ray Dalio's investment team for more than a decade, said that after a "sizable oil shock," he would expect that stocks would have priced in more potential pain.

"That looks underpriced right now," he said.

Prices for global benchmark Brent crude (BRNK26) are up 67% so far this year, currently trading around $102 a barrel, but they tapped highs around $119 earlier this month on fears of a protracted Iran conflict. The S&P 500 SPX is down 3.7% this year and the yield on the 10-year Treasury note BX:TMUBMUSD10Y has been rising, but it remains where it stood roughly one year ago.

"Stocks have actually gone up relative to long-term bonds since the Iranian war began," Elliott said, adding that this makes little sense. "You have a huge oil shock going on in the economy and a huge erosion of real spending power, and you're telling me that growth expectations are actually better than they were on March 1? That's what's priced into the markets."

Elliott said that even if oil prices normalize tomorrow, investors are likely underestimating the economic hit from the oil shock that is already playing out.

Other trades that had been winners up until this month have also taken a hit, including Japan EWJ, Europe VGK and emerging-market stocks EEM. That's because higher oil prices have introduced more volatility to markets, he said. The Cboe Volatility Index VIX - known as the VIX or Wall Street's "fear gauge" - is hovering around 26, above its long-term average of 20. It was at around 17 before U.S. and Israel launched strikes against Iran in late February.

"It's just a totally different volatility environment, which is basically forcing everyone to cut their books and close positions, regardless of whether it was a good trade or not," Elliott said. Gold (GC00), he argued, has remained a winner, as it's still up 44% over the year, but it has recently started to see macroeconomic investors take profits on those gains.

Elliott cautioned that consumers are going to start seeing fuel surcharges show up in gasoline prices, although this will take a few months to start flowing into other parts of the economy. Gas prices in the U.S. have risen from an average of $2.99 on March 1 to $3.99. If oil prices remain where they are, they will be above $4 in a week or two, he predicted.

"We definitely will have a meaningfully higher inflation environment for the next six months," Elliott said, adding that for every month the conflict extends, consumers will see another two months of elevated prices.

Elliott's Unlimited HFND Multi-Strategy Return Tracker ETF HFND, which aims to track returns of hedge funds, is up over 3% this year. The Unlimited HFGM Global Macro ETF HFGM, which launched last year, tries to replicate strategies of global macro hedge funds and invests in long and short positions across assets such as stocks, currencies and commodities. That ETF is up nearly 12% this year.

"The advantage this year has really been holding long positions in things like gold and metals, as well as long positions in global asset prices, and then being smart, locking in those gains as we've moved to a more volatile environment," said Elliot, adding that picking up positions in oil coming into the war has also worked out for macro managers.

-Barbara Kollmeyer

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