The Independent Market Observer

What Would a War with Iran Mean for the Markets?

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jan 3, 2020 11:25:10 AM

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Following the news regarding a U.S. drone strike, the reaction from U.S. markets is minimal so far, while global markets are experiencing more volatility. The news this morning that a top Iranian commander was killed in a U.S. drone strike sent global markets reeling. According to news reports, Iran is now vowing to retaliate, which means terrorism and cyberattacks are likely. Here in the U.S., apparently, Congress was not notified of the strike ahead of time. The heightened risk factors we must now consider include increased domestic political dysfunction, a rising risk of military action (either by us or against us in an already troubled area), and a probable disruption of the oil markets.

How will the U.S. markets react?

As a citizen, I am paying attention. As an investor, I am asking what this potential chaos will do to the markets. The answer is not what the headlines suggest. While some short-term volatility is almost certain, the actual effects, over time, will likely not be nearly be as bad as might be feared.

Let’s start with the initial reaction. As I write this, U.S. stock futures are down less than 1 percent, or not much. Regarding the S&P 500 Index, if we do get a similar decline, it would take us back down to the levels of Tuesday afternoon. Not a terrible hit. Based on what we know about the markets now, we’re just seeing normal volatility.

What about the global markets?

Other markets are reacting more severely, of course. Oil prices were up about 4 percent, while global stock markets were down a bit more than U.S. futures. Yet again, in both cases, this level of volatility is normal. Oil prices, for example, jumped a bit less than they did following the attack on the Saudi oil facilities in September. The same reason caused the volatility—the fear that the supply of oil from the Middle East would be at higher risk. Investment in gold is a classic hedge against risk, but prices for the metal are up by only about 1 percent. So, even the stronger market reactions are not indicating panic.

Market risk mitigators

There are a couple of reasons for the lack of panic. First, the major potential risk—to oil markets—is mitigated by the fact that the U.S. is now the largest producer of oil and essentially approaching energy independence. Our oil supplies are much less vulnerable than they were, and the availability of oil exports from the U.S. means that other countries have an alternative source. Second, in general, a war sends stock markets into positive territory after the initial period of volatility. My colleague, Anu Gaggar, of Commonwealth’s Investment Management and Research team, posted a great article a couple of years ago, during the height of the North Korea confrontation, that shows this fact clearly.

Why war could be damaging

Anu’s analysis does, however, point to the reasons why war might be more damaging this time around. The major factor, from a market perspective, is that most companies now have global supply chains, so a war anywhere could disrupt the business environment around the world. This concern was real during the North Korea scenario. In the Middle East, however, the concern is not as great because most companies—with the big exception of the energy companies—do not source extensively from this area. And obtaining oil, as I discuss above, will likely not be a significant problem over time for the U.S. or other countries.

Should we be worried?

The headlines are scary—and deservedly so. This event could lead to a major escalation of the U.S.-Iran conflict, and it will likely result in military actions from both sides. Expect more headlines. Also, expect more volatility in the markets as a result. The prices of oil and gold will certainly bounce around with the news.

Over time, though, any damage to your investments is likely to be relatively small and short term. The effect might even end up being positive. As a citizen, I am paying attention and concerned. As an investor, not so much.

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