Charts of the Month

CHART 1 – DEFENDING THE FISCAL DEFICITS

We are in an era of fiscal dominance, in which huge budget deficits are commonplace.

Going forward, these deficits are likely to be driven increasingly by defence spending.

The chart below shows the top 10 nations for military spending. The values are the annual dollar amounts spent, based on 2024 figures.

The US is, by some margin, the most dominant player. It allocated around U$1trn to its defence budget last year.

Unsurprisingly, Russia and Ukraine make the list, whilst the UK spends just shy of U$100bn p.a. on its military.

The light blue bars represent NATO members and this is where most of the expenditure is likely to appear over the coming years.

In late June, against a backdrop of heightened geopolitical tensions in the Middle East, the NATO countries finally agreed to President Trump’s demands to raise their defence spending from around 2% of GDP to 5%.

That means several hundred billion dollars more will be spent each year on rearmament and various other military initiatives.

CHART 2 – STEALING A MARCH ON NATO

The anticipated surge in defence spending is likely to be a key driver of public sector activity and, therefore, economic growth over the coming years.

But have markets already priced this in?

The chart below shows the performance of the European defence stocks (dark blue line) against their US equivalents (red line) since early 2022. The light blue line shows the S&P 500’s total return. All figures are shown in USD terms.

The start of the Russia-Ukraine war sparked a big rally in European defence stocks, but this trend accelerated sharply immediately after President Trump’s second inauguration in January.

The scale of the outperformance this year dwarfs the prior move, which suggests investors believe the NATO agreement to boost defence spending bears a greater influence on share prices than the prevailing regional conflicts.

However, with European defence stocks rising around fivefold in just three years, a lot of the good news appears to be priced in.

CHART 3 – WHAT WAR?

For the most part, markets have taken the recent Middle East turmoil in their stride, but it is rare for geopolitical events to sustain permanent damage on investor sentiment.

The main concerns were around energy markets, especially when the Iranian’s threatened to close the Strait of Hormuz, through which approximately 20% of global oil supplies flow.

However, the oil price proved to be far more resilient than many feared.

The chart below shows the daily % change in the Brent crude oil price, going all the way back to the late 1980s.

Last month, the biggest daily move was +7%, which resulted from Israel’s initial strikes on Iran’s nuclear plants. An identical move occurred on the downside when a ceasefire was announced.

This means the recent Middle East unrest has caused much less oil price volatility than the likes of Covid, Russia’s invasion of Ukraine and even the 1990 Gulf War.

Which suggests weak fundamentals in energy markets are keeping a lid on the geopolitical premium.

CHART 4 – BELEAGUERED BRENT

The chart below helps to explain why the oil price has remained weak, despite the recent Israel/Iran war and the ongoing conflict in Eastern Europe.

Thanks to the growth of its shale industry over the past decade, the US is now (by far) the world’s largest producer of oil.

It currently represents over 20% of total global output, more than double that of any other individual producer, including the historically dominant actors like Saudi Arabia and Russia.

This US dominance significantly reduces the impact of flare-ups in geopolitical “hotspots,” like the Middle East and some other oil-producing regions.

In fact, the surge in US production is the main reason why the oil market is widely regarded as being oversupplied.

This is why Brent crude has posted a significant loss over the past 12 months, despite the recent conflagration in the Gulf.