What Mideast Escalation Means for Markets

The U.S. airstrike that killed the top Iranian military commander last week was a major escalation in Mideast tensions.

In fact, it would be difficult to overstate the geopolitical significance of this action. Iran likely will retaliate, possibly with attacks on American military personnel overseas.

We cannot dismiss the risk that the situation may escalate further into a broader conflict. However, from a markets perspective, we want to be careful not to overstate the potential impact. History shows that stocks have largely shrugged off past geopolitical conflicts. We looked at significant geopolitical events dating back to 1990 and found that the Dow Jones Industrials Average has fallen an average of only 2% during 16 major geopolitical events, including the Gulf War, Iraq War, and 9/11. Over the subsequent 3 and 6 months, the Dow rose 88% of the time, with average gains of 5% and 7.9%, respectively.

A review of 20 major geopolitical events dating all the way back to World War II showed stocks had fully recovered losses within an average of 47 trading days after an average maximum drawdown of 5%, according to a CFRA study.

“As serious as this escalation is, previous experiences have indicated it may be unlikely to have a material impact on U.S. economic fundamentals or corporate profits,” said LPL Financial Chief Investment Strategist John Lynch. “We would not be sellers of stocks into weakness related to this event, given stocks have weathered heightened geopolitical tensions in the past.”

Oil prices have jumped on the Iran headlines due to the significant production at risk in the region. We do not expect oil to climb significantly from current levels based on the muted reaction to the Saudi production disruption in September 2019 and significant U.S. shale resources. However, energy markets bear watching given the potential impact of higher energy costs on consumer and business spending.

While heightened geopolitical uncertainty can be unsettling for investors, we will continue to focus on the fundamentals supporting gross domestic product, inflation, employment, interest rates, and corporate profits when making investment decisions.