As the conflict in the Middle East continues to unfold, we can look to history to help understand the potential economic and market impact.
Our Top Market Takeaways for October 16, 2023.
Market update
Navigating uncertainty
The Israel-Hamas War has shocked the world.
The geopolitical ramifications are important, and will likely not be fully understood for years. The most important impact is the human one, and the loss of life is tragic. Our thoughts are with all of those who have been affected, including our colleagues, clients and their families.
While it is difficult to do so during times like these, our job as investors is to assess what impacts the conflict might have on the global economy and financial markets, and then determine if we need to change the advice we are giving about portfolios. Today, we work to examine the unfolding crisis from that lens.
How could this crisis evolve?
The situation is incredibly fluid, but it’s worth noting the geopolitical web is a complex one and stretches beyond the two sides involved. For instance, the attack seems to have put a stopper on U.S.-brokered negotiations around Saudi-Israel relations, things seem to be intensifying between Israeli forces and Iran-backed Hezbollah militants at the Lebanon border, and questions abound over whether Iran was involved in some way.
To gauge any investment impact, we are closely watching the potential for escalation, and the follow-through effect on natural resources, given it seems like the clearest link to corporate profits, inflation and consumer sentiment.
To that end, we examine two primary scenarios: (1) if the conflict remains geographically contained, and (2) if it escalates.
(1) If the conflict remains geographically contained.
Neither side are key oil players, and the conflict as it stands does not meaningfully impact oil production or supply. So far, markets seem to think this will remain the case. Brent crude prices finished last week +7% higher but it’s notable that that’s still well off this summer’s highs.
This line chart shows the price for Brent and WTI crude oil since the start of 2023 to today. The unit is dollars per barrel. Both charts follow a similar path. The WTI line begins at $77/bbl and remains volatile between $75-80 until the beginning of March, when oil sold off to its series low of $67 amid growth concerns during the regional banking crisis. From there, oil prices spiked to $83 by the middle of April before falling back close to $70 again and remaining there for much of May and June. From the end of June, prices rose sustainably toward a high of $94 on September 27. Since then, prices have come off slight to today’s levels of $87. The Brent crude line follows a similar path, largely remaining ~$5 above the WTI line for the most part. The line begins at $82 and bounces between the $80-90 range until early March, when prices sell off below $75 at their lowest. From there, we see a temporary spike in Brent to $87 by mid-April before moving lower again, ultimately reaching a series low of $72 in mid-June. As with WTI, Brent prices rallied from there to their peak of $97 before giving back some gains to end at $91 today.
The more muted moves also come as global oil supply and demand today are pretty balanced. This is different than conditions faced when Russia invaded Ukraine; back then, oil supply was already lacking relative to demand, and as the event disrupted even more supply, prices soared.
To us, this means that today’s markets can probably handle a moderate disruption—for instance, if the U.S. were to more strictly enforce sanctions on Iranian oil. Iran accounts for about 4% of global oil supply, and as tensions between the U.S. and Iran have thawed a bit lately, enforcement of those sanctions has been laxer. This has meant that some Iranian oil has still made its way to the market, and a harder line taken on enforcement would take some of this offline.
(2) If the conflict escalates.
Much is unclear, but a wider conflict would bring greater risk. Some have drawn parallels to the 1973 Yom Kippur War, during which Arab OPEC countries implemented an oil embargo targeted at nations that had supported Israel. As a result, the embargo spurred oil prices to surge over 300%, catalyzed high inflation and an economic recession, and led to a prolonged rout in stock markets.
There isn’t any evidence so far of similar actions being taken today. Israel has better relations with other Arab countries compared to then, and global oil supply is not as concentrated. However, the conflict could escalate, for instance, if it formally pulls Iran into the fold. A scenario that sees disruption to important shipping routes like the Strait of Hormuz—which traffics about 20% of global oil consumption—would be much harder to digest.
Here, it’s possible other producers could step in to stem some of the bleeding. The U.S. has been rapidly adding supply, and given time, it could add quite a bit more. It wouldn’t be enough to hold prices steady, but it would help to mitigate some of the pain. Some comfort might also come from the fact that the U.S. is less energy-intensive than it used to be: compared to the early 1970s, it now takes over 70% less oil to generate one unit of GDP.
So what should investors do?
There may be volatility as investors wait to learn more, but in the long run, geopolitical events generally haven’t had a lasting impact on markets.
Here, we’d refer to the seminal work of Michael Cembalest, Chairman of Market and Investment Strategy for J.P. Morgan Asset & Wealth Management, who examined a handful of geopolitical events in post-war history. Most of the time, the business cycle has mattered more for investors, which means that barring a major economic disruption or imbalance, the effect of geopolitics on markets has tended to be short-lived.
This chart shows the S&P 500’s performance during the 12 months leading up to a geopolitical event and the two years following. The events that are charted are the Korean War (06/1950), Soviets into Hungary (11/1956), Six-Day War (06/1967), Soviets into Czechoslovakia (08/1968), Arab-Israeli War (10/1973), Soviets into Afghan. (12/1979), Martial law in Poland (12/1981), Falklands War (04/1982), US invades Grenada (10/1983), US invades Kuwait (02/1991), Serbians into Kosovo (02/1998), September 11 attack/US invasion of Afghanistan (2001), US invades Iraq (03/2003), and N. Korea sinks S. Korean Navy vessel (03/2010), Russian annexation of Crimea/Invasion of Ukraine (03/2014), Fall of Mosul to Islamic State (6/2014), Russia invades Ukraine (02/2022). The data series are indexed so that the month the conflict occured is labeled as 100. The y-axis scale goes from 60 to 140. The highlighted line represents an average of the geopolitical events 12 month performance. The average line starts indexed at 95, 12 months prior to conflict, and as the months pass the line has a slight upward slope until 24 months after the conflict start where the line finishes at 114. The takeaway is that the equity market tends to move past geopolitical conflicts fairly quickly, unless it results in a global supply shock, as was the case with the OPEC oil embrago in the 1970s. However, it should be noted that oil supplies are much less concentrated now than they were then with the U.S. now a major oil producer.
Remember that staying invested in a diversified, goals-aligned portfolio has protected portfolios throughout countless geopolitical crises, wars, pandemics and recessions.
From there, when uncertainty is high, it helps to focus on the fundamentals. Today’s backdrop of sticky inflation (see last week’s U.S. CPI print), the highest central bank policy rates in over a decade and political division in Washington must also be taken in balance with a robust labor market, a still-strong consumer, resiliency in corporate America, and fiscal spending efforts around industrial policy and AI that are doing real work to innovate, grow and transition the economy.
We think prospects for a soft landing for the U.S. economy have grown, and with more reasonable valuations, positive seasonal trends and earnings expectations climbing as we enter the Q3 reporting season, we think equities offer opportunity. With bond yields as high as they are today, fixed income seems to be compensating investors for uncertainty. For instance, as the geopolitical turmoil has unfolded and policymakers across much of the developed world have signaled the end of rate hikes, 10-year Treasury yields have fallen almost -30 basis points from their highs the week before last.
In all, while there are undoubtedly risks, we think there’s good value in the market based on what we know. Your J.P. Morgan team is also here to discuss your portfolio, the volatility, and how we can help.
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• Past performance is not indicative of future results. You may not invest directly in an index.
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