Assessing the Market Impact of Escalating War in the Middle East

This week marked the first anniversary of Hamas’s terrorist attack on Israel, with fighting intensifying in the twelve months since. The latest development saw Iran launching ballistic missiles into Israel—which caused minimal damage—and Israel moving troops into southern Lebanon.

In short, geopolitical tensions seem to have only gotten worse in the past year, and many investors worry about the accompanying uncertainty on trade, oil markets, and global economic growth. In the week ending October 4, for instance, crude oil prices soared?9.1% on concerns that Iran’s oil fields would be targeted. It was the biggest?advance for oil prices since March 2023.(1)

Investor concerns are understandable. But given what we know from the long history of regional conflicts—and in particular conflicts involving the Middle East—we do not see a high likelihood of major ripple effects on global growth or equity markets. At this stage, we also see a very low likelihood of war spilling over into major economic centers, like the U.S., Europe, Japan, and China, which we think means the impact on global GDP will be negligible.

To be fair, Iran’s recent barrage of missiles did result in market volatility in both equity markets and oil markets, as did Hamas’s initial attack on October 7, 2023. But short-term volatility in response to the outbreak of geopolitical crises and regional conflicts is historically common. Looking back at 54 crisis events since 1907, the Dow Jones Industrial Average has fallen an average of -7.1% during the crisis period, with the index posting an average gain of +9.7% in the six months that followed.(2)

We also know that looking back at conflicts since 1925—including the Korean War, Vietnam, the Cuban Missile Crisis, the Iran-Iraq War, two U.S. wars in Iraq, and so on—it was only World War II that resulted in a bear market. The Iran-Iraq War lasted from 1980 to 1988, which corresponded with a strong bull market that lasted from 1982 to 1987. And with the current war, since the fighting broke out one year ago, the S&P 500 and global stocks as measured by the MSCI World are up approximately +30%.(3)

The point here is not that armed conflict is bullish. The point is that uncertainty leading up to a conflict is what tends to weigh on markets. Once the conflict is averted or fighting breaks out, the uncertainty fades and markets can start to price-in the effects on corporate earnings, financial markets, and global economic growth. In this instance, I think markets are telling us that the impact on global economic growth should be minimal.

There’s an argument that the real economic risk is rising oil prices, not necessarily a blow to global economic growth or corporate earnings. That’s fair, but it’s worth remembering that oil prices (chart below) remained firmly above $100 a barrel from the beginning of 2011 through the summer of 2014, during which time the U.S. economy grew and the stock market went up by over +50%. Higher oil prices do not necessarily mean economic recession or weak markets, especially in the current environment where oil prices seem to be more range-bound in the $70 - $80 a barrel zone.

It is also important to note that Iran produces a little over 3 million barrels per day of oil, which is about 3% of global daily output. That’s not insignificant, but it’s also true that because of Western sanctions, about 90% of that oil gets exported to China. Saudi Arabia and other OPEC+ countries have plenty of spare capacity to make up for any hit to global supply, which they would likely do if prices continue to rise.??

Bottom Line for Investors

Geopolitical crises and wars are highly undesirable for their impact on the daily lives of affected civilians, global stability, trade, and so on. But a global recession requires trillions of dollars’ worth of damage to the global economy, which current crises do not seem capable of delivering. S&P 500 companies earn less than 1% of revenue from the affected regions. ??

Market volatility may continue if the conflicts escalate, and news coverage will almost certainly be constant. But investors would be wise to foresee this environment for the next few months—or perhaps longer—and try to remember that the desire to react to a crisis is almost always counterproductive and costly. Now is a time to remain patient and focused on U.S. economic fundamentals, which we think remain quite strong.

1 Morningstar. 2024. https://www.morningstar.com/news/marketwatch/20241007123/brent-crude-tops-80-a-barrel-on-fears-middle-east-war-will-threaten-supply

2 NBER. chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.nber.org/system/files/working_papers/w8992/w8992.pdf

3 Fred Economic Data. October 7, 2024. https://fred.stlouisfed.org/series/SP500

4 Fred Economic Data. October 2, 2024. https://fred.stlouisfed.org/series/DCOILBRENTEU

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