As widely reported, the United States and Israel launched a strike on Iran Saturday morning, targeting both military infrastructure and the country’s leadership. While geopolitical developments continue to shape markets, we acknowledge the lives lost, which underscores the seriousness of the moment beyond financial considerations.
There are strong indications that the conflict may extend beyond the relatively contained hostilities that we’ve seen in the past. In addition, mounting internal pressures — building on the unrest seen last month — may further strain Iran’s new military and civilian leadership, increasing the risk of a more forceful response and raising the possibility of broader regional involvement. At this stage, it remains unclear how developments will unfold or how extensive or prolonged the conflict could become; however, the risk of escalation must not be discounted.
Given this uncertainty, some degree of equity market volatility should reasonably be anticipated. Crude oil prices have surged, although some of the more dire projections that have been mentioned (including the potential for oil to spike to $100/barrel) still appear quite pessimistic, likely requiring an extended disruption of the flow of middle eastern oil. In early Asian trading on Sunday night, Brent crude quickly rose by 13% (topping $82/barrel) before easing to under $78 in intraday trading today. The degree of volatility in crude prices illustrates the overreaction that can occur at a market open with the potential for a quick reversal as more liquidity and transactions aid in price discovery. Nonetheless, the upside risk to prices will persist as the conflict unfolds.
Nonmarket-related developments can and will have the potential to move markets. Certainly, an unexpected widening of the conflict remains a risk; but developments such as OPEC’s announcement of expanded production and hints by the Trump administration that sanctions on Iran could be eased depending on the tone adopted by its new leadership could also serve to de-escalate tensions or mitigate the risk of a more pronounced or prolonged surge in crude oil prices. The reverse is also true, if other countries are drawn into the conflict or other geopolitical developments point to a widening instability. As of today, there’s no sign that tensions will ease in the near term with military operations expected to continue for some period of time.
One significant risk that can’t be fully discounted is the threat issued by Iran’s Revolutionary Guard (IRGC) that “no ship is allowed to pass the Strait of Hormuz.” That’s very significant to the flow of oil from the region, as roughly 20% of global crude oil production passes through the strait en route to global buyers. The full extent of the IRGC’s intent and ability to effectively close the route remains to be seen, but the threat alone appears to be causing some shippers to suspend transit, creating a bottleneck inside the Persian Gulf and interrupting the flow of oil that — if sustained — would push crude oil prices higher should it persist.
As of early Monday morning, Asian stock markets were trading lower, with the Nikkei 225 trading off about 1.4% and the Hang Seng off 2.1%. European exchanges followed suit, trading down by 1-2.5%. The U.S. stock market opened soft, but had edged into positive territory as the day progressed. Investors may be taking a wait-and-see stance rather than paring back risk aggressively, but appetite for safe haven assets is still evident, with gold up 1.8% for the day and the U.S. dollar edging higher. Long-term Treasury yields have been volatile, first falling as investors sought safety before capitulating and heading higher as higher oil prices stoked inflation concerns.
It’s important to note that market reaction in the immediate aftermath of the outbreak of a military conflict is typically — and understandably — a negative for risk assets, but investors should be cautious in assuming what the impact will be over an extended period. The recovery in stocks and reversal in Treasury yields as trading progressed today affirmed that point. The initial shock often prices the new risk into markets quickly. The direction for both traditional safe haven and risk assets will depend significantly on further developments and the actions and reactions of all sides involved.
As noted, one key risk would be further exacerbated by a prolonged closure of the Strait of Hormuz, creating a potentially extended disruption in the flow of crude oil. Higher prices would lift inflation and weigh on growth globally, but particularly for those countries that are most dependent upon oil sourced from the region. Notably reliant are a number of Asian countries, including India and China. The United States would certainly feel the impact but is much more insulated, with only an estimated 7% of its crude needs fulfilled by Middle Eastern oil.
Conversely, any sense that tensions are sustainably de-escalating could lead to a reversal in the risk-off trade and a stabilization in investor sentiment. As illustrated by the terms such as the “fog of war,” clarity about the near-term at times like this is impossible to achieve. Much will depend on the path from here, whether escalatory or de-escalatory, and whether the conflict remains contained or ultimately expands, drawing in more countries in the region. Investors should be prepared for the potential that volatility could persist for some period of time as the situation unfolds. As always, it’s important to recall that volatility is two-sided, with selloffs often followed by sharp reversals. It’s that inherent unpredictability that makes market timing an impractical strategy.
We’ll continue to closely monitor developments, but we remain broadly comfortable with our portfolio positioning. During periods of uncertainty, diversification and maintaining adequate sources of cash and liquidity remain paramount, providing a relative source of stability and a source of cash to sustain investors through the period of volatility.
If you have any questions or concerns, please contact your PMFA relationship manager.
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