HAMISH MCRAE: Do markets accept ongoing conflict now as a fact of life?

What is happening in the Middle East is so terrible in human terms that it seems wrong to be discussing the implications for investment. But that is what markets have to do.

However horrible things are, and however huge the uncertainties, the plain fact is that the markets have to try to work out what might happen to the economies of different countries, to the price of the various types of assets, to interest rates, inflation, and so on – and all amid the fog of war.

While we cannot know what will happen in the coming months, there will clearly be a period of extended conflict. This isn’t just about the immediate consequences of last week’s Israeli strike. The practical question facing us all is how best to invest in an increasingly dangerous world.

Some short-term reactions have already become evident, but they have been strangely muted. The gold price has jumped, though it’s still a little below its all-time peak in April. Oil prices climbed too, but at $75 a barrel on the Brent measure, they are down on where they were at the start of this year.

As for shares, naturally they too took a hit, but the FTSE 100 index is still close to the all-time high it reached on Thursday.

It is almost as if the markets are accepting continuing conflict as a fact of life, just another of the string of things they have learnt to cope with. Can that be right?

There are two responses to that. One is to say the world economy is huge and regional tensions will always burst out, as we have seen in the past three years.

What happened last week was part of that pattern. But because the global economy is so big, the ability of these conflicts to inflict damage beyond the countries and people affected is limited.

To put the point harshly, the argument is that while this is horrible for the people caught up in the conflict, it is manageable as far as the wider economy goes.

The other response is to say this is far too complacent. Quite aside from its human toll, war destroys wealth. Resources have to go into reconstruction and additional defence spending afterwards.

Money that goes into military hardware and armed service salaries is money not available for education, health and all the other things that government supports.

Though these conflicts are regional, and we hope against hope they will remain so, it would be naive to suppose we will not feel the effects across the developed world. That leads to practical implications for us all. Disruption is never good. It puts up the cost of everything. It leads to higher government borrowing – yes, even higher – for we are already in a mess across the developed world on that score.

That inevitably puts up interest rates to higher levels than they would otherwise have been. And since the central banks will probably not put up rates by enough, I’m afraid the outcome must be higher-than-expected inflation. So what should we do? 

I take comfort in looking at what happened after the Second World War, which saw the destruction of life and wealth far beyond anything on the distant horizon now.

Industry and commerce recovered quite swiftly and, after a lag, share prices reflected that. House prices took a while to steady, before starting their long, if uneven, march upwards.

Inflation was suppressed at first but eventually burst out even more viciously than we have seen in the past five years. And anyone who held cash or bought government securities lost their shirts.

So we should go on saving and investing. We should hold as little cash as practicable, and I personally hate the idea of holding gilts – UK Government bonds – even at their apparently decent yields.

Property may not be a great buy at the moment, with stamp duty changes, non-doms pulling out, landlords selling up and punitive council tax rises. But we all have to live somewhere, and a mortgage is a form of forced saving. On a long view, owning one’s home must make sense.

And then there are equities, and note this. If, after everything that has been thrown at big British companies, the FTSE 100 index is hovering around its all-time high, what on earth would it do if the clouds lift a little?