The War in Iran Could Last Weeks. Why Stock Investors Are Shrugging.
Key Takeaways
- U.S. stocks rebounded from early losses Monday morning as investors shook off concerns that conflict in the Middle East will be a major headwind for equities.
- Wall Street analysts expect an oil price spike will be short-lived and have little impact on either U.S. inflation or economic activity.
For the second time this year, U.S. military action over the weekend is ramping up the uncertainty on Wall Street to start a new week. Investors, having been here before, are taking it in stride.
The U.S. and Israel on Saturday launched attacks that killed Iranian leader Ayatollah Ali Khamenei and several other top political and military leaders. The U.S.-Israeli campaign continued on Monday as Iran carried out retaliatory strikes across the Middle East. President Donald Trump on Monday said combat operations in Iran could last “four to five weeks” but noted that the U.S. has the “capability to go far longer than that.”
Stocks fell sharply at the open on Monday before rebounding within just a few hours. The tech-heavy Nasdaq Composite—down nearly 1.5% when markets opened—was recently up 0.2%, while the S&P 500 and the Dow Jones Industrial Average were down only slightly. (Read Investopedia’s live coverage of today’s trading here.)
Why This Is Important
The U.S. and Israeli campaign against Iran heightens uncertainty about the balance of power in the Middle East, and could disrupt global oil supply in the near-term. However, the U.S. economy and stock market are expected to be relatively well insulated from oil supply shocks.
The conflict in the Middle East affects the U.S. stock market primarily through energy markets due to the region’s vast supply of crude oil. About 20% of the world’s oil flows through the Strait of Hormuz, a waterway bordering Iran that connects the Persian Gulf and the Gulf of Oman. The Iranian government over the weekend said no ships would be allowed to transit the strait, and traffic through it has reportedly plummeted.
Oil prices are a powerful driver of inflation because they affect the price drivers pay for gasoline, an unavoidable expense for the vast majority of Americans, and impact shipping costs, which businesses pass along to consumers through price adjustments.
Like stocks, oil price movements have moderated after prices spiked when trading began on Sunday evening. West Texas Intermediate futures, the U.S. crude oil benchmark, were recently up nearly 6% at around $71 a barrel after hitting an 8-month high of about $75 Sunday night.
The market reaction on Monday was no surprise to experts on Wall Street. “The initial market response is generally to raise risk premium on the back of higher uncertainty,” wrote Goldman Sachs analysts in a note on Sunday. But, they note, geopolitical uncertainty alone rarely pressures the market long-term. “It is likely that without sustained oil price shifts, the asset impact will begin to ‘localize,’ shifting back towards directly affected assets,” and the firm doesn’t count U.S. stocks among those assets.
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UBS analysts said on Monday their base case is for a spike in oil prices to reverse “once it becomes clear that supply disruptions are temporary, critical oil infrastructure is not destroyed, and the need for continued military action fades.”
Granted, that scenario is far from certain. While a weakened Iranian military will likely struggle to block the Strait of Hormuz for long, Iran remains a major global oil supplier, producing nearly 5% of the world’s crude and natural gas liquids in January, according to International Energy Agency data cited by UBS. “Any potential power vacuum within Iran could put Iranian energy production at risk over the medium and long term,” the firm’s analysts wrote.
What’s more, the Iranian regime may have a vested interest in keeping energy markets volatile. The Trump administration is attuned to the risk higher oil prices pose ahead of November’s midterm elections, in which inflation and the cost of living are expected to be top of mind for voters. Iran is also attuned to that risk, according to UBS, “and it is in its interests to prolong the conflict and disrupt energy flows to attain leverage.”