Geopolitics and Market Volatility

Recent news has reported military actions involving the US and Israel targeting Iran, with significant impacts on leadership, military facilities, and nuclear infrastructure. In response, Iran has launched missile and drone strikes throughout the Middle East and has threatened to disrupt shipping through the Strait of Hormuz, a critical global oil chokepoint and the busiest oil shipping channel where a substantial portion of the world’s oil and gas is transported. About 20 % of global oil and gas passes through this channel. Iranian officials have stated their intention to block oil exports from the region. With the situation unfolding quickly, many investors are understandably concerned about the potential effects on financial markets, energy prices, and their investment portfolios.

We may see more volatility in the days and weeks ahead, and oil prices could continue to rise further. Uncertainty could weigh more heavily on markets, but trying to time the market has historically been one of the worst things an investor can do.

The quote from President Dwight Eisenhower, “Plans are worthless, but planning is everything,” is a good lesson for these events, as geopolitical events are unpredictable, but they occur regularly. The process of structuring diversified portfolios and making financial plans is designed to reduce uncertainty and market shocks.  While each event is unique, the stock and bond markets have navigated countless wars, regional conflicts, financial crises, etc., and, as this will not be the last time we see volatility in the markets, the key is to separate the noise from facts and not make short-term portfolio decisions that could disrupt your financial plan.

The most direct way that Middle East conflicts affect financial markets is through global energy prices. Iran is a member of OPEC and produces around 3 million barrels a day of oil. Oil prices had already been rising before the strikes on Iran, and the immediate reaction after was a further jump in oil prices. While Western countries do not directly import oil from Iran, any disruption to supply can raise prices worldwide. If we look at this from an outside lens, current oil prices remain well below the 2022 peak of nearly $128 per barrel when Russia invaded Ukraine. Although oil prices could continue to rise, in 2018, the US also became the world’s largest producer of oil and natural gas, with current production exceeding other major players like Saudi Arabia and Russia. While the US still relies on the global energy markets, this level of production helps to insulate the US economy from disruptions.

It is also important to remember that oil prices are very hard to predict. When Russia invaded Ukraine, many believed that prices would go even higher and would remain elevated indefinitely. Instead, prices stabilized and declined far sooner than anyone thought. Similarly, the US operation in Venezuela in January briefly led oil prices higher, but had little longer-term effect.

For long-term investors, the most important lesson from past events, whether financial or geopolitical related, is the value of staying invested. Markets have navigated wars before, from World War II to the Gulf Wars to the wars in Iraq and Afghanistan. These events caused a short-term spike in volatility, but ultimately, the main driver of markets is long-term economic fundamentals. Iran plays a minimal role in investment portfolios, as it has been under heavy sanctions for years; therefore, investors have little to no exposure to the country allocation-wise.

Markets rebound unexpectedly, and missing even a few of the best days during a rebound significantly reduces long-term returns. Lastly, if we look at World War II, the Korean War, Vietnam, the Gulf War, and the Iraq War, the average market return during these major wars was 10.2%, with just slightly higher volatility than the norm. In the end, the conflicts matter to the markets because of oil, and if oil prices rise sustainably and head towards $90 per barrel, this could become a new market negative if believed to last. The key to whether it lasts is the Strait of Hormuz traffic; the sooner more ships are crossing the strait, the better for markets.

The opinions voiced in this are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.