Israel-Iran Conflict: How Wars Impact Investors

Investor Concerns: Will Conflicts Escalate?

While the humanitarian consequences of these conflicts are paramount, investors must also understand their impact on markets. A major concern among investors is the potential for these events to escalate into full-scale global wars. While this possibility always exists, recent history suggests otherwise.

Even severe conflicts, such as Russia’s invasion of Ukraine and Hamas’s attack on Israel, have largely remained contained, resulting primarily in short-term stock market volatility. This isn’t to downplay the severity of these conflicts, but rather to highlight that overreacting with investment portfolios can be counterproductive. In such times, maintaining perspective and focusing on historical lessons and long-term market trends is crucial.

Historical Market Reactions to Geopolitical Events

Historians often view each event as unique, with distinct narratives, causes, and consequences. Economists, conversely, seek patterns and similarities across events to draw broader conclusions. For investors, both perspectives are vital to discern which lessons apply and which do not. As the saying goes, “history doesn’t repeat itself, but it often rhymes”.

Looking back over the past 25 years, geopolitical events, including Middle East conflicts that influenced oil prices like the Iranian drone strikes on Saudi Arabia in 2019, demonstrate a common pattern. While short-term market swings are common, markets have typically recovered from geopolitical shocks, often within weeks or months. The more significant factor during these periods has consistently been underlying business cycle trends.

Global Oil Prices: A Key Transmission Mechanism

In the immediate term, oil prices often serve as a direct conduit through which regional conflicts affect the global economy. The latest conflict’s initial market reaction centered on energy markets, with Brent crude futures rising above $74 per barrel. While still volatile, oil prices have since fallen back towards $70 per barrel amidst signs of possible de-escalation.

Oil prices are a critical input for nearly all products and services, making their volatility impactful on the global economy. Higher oil prices translate to more expensive gasoline and increased transportation costs, subsequently raising prices for consumers and businesses. The potential closure of vital shipping lanes, such as the Strait of Hormuz in the Persian Gulf, which carries approximately one-third of the world’s oil supply, further compounds this concern.

However, it’s essential to maintain perspective on current oil price levels. Despite recent fluctuations, prices remain well below the peaks of over $120 per barrel seen in 2022 during the early stages of the Russia-Ukraine conflict. The current price of around $70 per barrel falls within the range experienced over the past few years, with fluctuations between $60 and $82 per barrel occurring just this year.

Furthermore, the U.S. has significantly increased its energy independence over the last two decades. American oil production now exceeds 13.5 million barrels per day , and surprisingly, the U.S. is the world’s largest producer of both oil and natural gas. While the U.S. still relies on foreign oil and is susceptible to global price movements, this substantial domestic supply helps to insulate its economy and financial markets.

Long-Term Market Impact of Wars

For investors concerned about escalating global conflicts, a broader historical view can offer valuable perspective. From World War II to the Iraq War, markets have shown short-term reactions to conflicts, but their long-term performance has consistently been driven by investment fundamentals.

For example, World War II jump-started industrial production after the Great Depression, and led to a significant shift in the labor market with women entering the workforce. These factors helped propel the economy through the rest of the century. Similarly, the Gulf War affected oil prices, but also coincided with the Information Technology revolution of the 1990s. In contrast, the decade following the Vietnam War coincided with high oil prices and stagflation, resulting in poor market performance.

Again, none of this is to trivialize the humanitarian and societal consequences of these wars. For the current situation, much will depend on whether the conflict expands further or begins to de-escalate. The involvement of major powers and threats to critical supply routes add complexity, but history suggests that even significant regional conflicts tend to have limited long-term impact on global financial markets.

The bottom line? While Middle East tensions have created short-term market volatility, investors should maintain perspective and avoid overreacting to headlines. A portfolio aligned with long-term financial goals remains the best approach for navigating periods of geopolitical uncertainty.