On Middle Eastern Conflict and Stocks

The weekend attacks by Hamas on Israel—and Israel’s response—once again bring terrible images and stories of lives cut short, under threat or forever changed. Our hearts go out to all those affected. It is hard to think about analysing market effects when such tragedies unfold, but as ever, publications we follow are indeed turning to the market, weighing the potential effect on energy prices and stocks in general. At such times, we find it vital to tune down our emotions and approach things coolly, as our research finds markets do. Since markets opened Monday, any broad market reaction has been tough to see, considering world stocks rose both Monday and Tuesday.^[i] Oil and natural gas prices are up but well short of the spiking levels they reached in the aftermath of Russia’s Ukraine invasion last year—or even last month’s highs.^[ii] Greater volatility is possible, but we don’t think this conflict is likely to truncate this bull market (a long period of generally rising equity prices).

In our experience, regional conflict always unsettles investors. When the fighting is in the Middle East, we find sentiment gets especially tense, primarily due to the region’s contribution to global energy production.^[iii] Yet we have found conflict rarely ripples through markets in the way commentators we follow hypothesise. Yes, we think Russia’s war in Ukraine contributed to 2022’s market downturn, in which global stocks endured a bear market when measured in US dollars, and we will get to that shortly.^[iv] But in our view, that was just one piece of the story last year, and it is an exception in a very broad history of markets seeing through regional fighting—even in the Middle East. Sadly, conflict there has been near-constant in modern market history, giving us a broad sample size to look at. The next four charts do this, using America’s S&P 500 index for its long and reliable history to show early volatility usually fades as the shock wears off and markets assess the low likelihood of a material global economic impact.

Exhibit 1: The Six-Day War and Stocks

Source: FactSet, as of 21/11/2013. S&P 500 price index, 31/12/1966 – 31/12/1971. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.

Exhibit 2: Operation Desert Storm and Stocks

Source: FactSet, as of 21/11/2013. S&P 500 price index, 31/12/1989 – 31/12/1994. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.

Exhibit 3: Second Iraq Invasion and Stocks

Source: FactSet, as of 21/11/2013. S&P 500 price index, 31/12/2002 – 31/12/2007. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.

Exhibit 4: Israel-Hezbollah Conflict and Stocks

Source: FactSet, as of 21/11/2013. S&P 500 price index, 31/12/2005 – 31/12/2010. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.

Terrible as these wars were, stocks are ultimately a share in corporations’ future profitability, which generally hinges on global economic conditions. We find the uncertainty as a conflict approaches and erupts can hit sentiment hard, but then stocks usually weigh the total impact on global commerce, determine it will be negligible, and move on.

Even in the Middle East. In our experience, investors associate Middle Eastern conflict with sky-high oil prices—and therefore big inflation (broadly rising prices across the economy) and stock market declines—because of 1973, when the Yom Kippur War led directly to the Arab oil embargo, contributing to the early 1970s’ bear market.^[v] But in our view, this was the exception, not the rule. Other conflicts involving Israel didn’t trigger similar backlash, and in the wake of the Abraham Accords, other improvements in Arab-Israeli relations and the lack of unity amongst Arab nations today, we think an embargo is highly unlikely now. Some financial publications we follow warn Iran’s reported complicity in the attacks could disrupt regional supply—likely through escalated Western sanctions—but Iran hasn’t been a major player in global markets for years.^[vi] We think it would also be easy for other members of the Organization of the Petroleum Exporting Countries (a group collectively known as OPEC) to offset any Iranian output falls. Saudi Arabia and Russia’s ending this summer’s output cuts would more than do it, if they chose to go that route, and long-running geopolitical tension between the Saudis and Iran suggest that possibility isn’t far-fetched at all.^[vii]

Natural gas could be modestly more vulnerable given Israel’s increased global exports in recent years and role in helping curb Europe’s dependence on Russian gas last year.^[viii] On Monday, Israel’s energy ministry suspended production at the Tamar gas field, a major offshore facility, which should disrupt regional flows a bit, but we think the effect will be quite small compared to the disruptions that followed Russia’s Ukraine invasion last year.^[ix] If 2021 didn’t bring the severe shortages so many anticipated, it seems unlikely to us this will do so.

For this conflict to have a material, lasting effect on markets, it would likely have to spill over to a much broader theatre involving much bigger powers, in our view. One reason we think the war in Ukraine had an unusually large market impact last year was the threat of NATO involvement and the risk, however remote, of a hot war between nuclear powers in Europe. Even then, we don’t think this would have been enough to sink stocks into bear market territory had investors not been dealing with a host of other overlapping difficulties, including inflation, energy shortages, US Federal Reserve rate hikes, recession forecasts, supply chain problems, China’s economy and more.^[x] In our view, today’s landscape is much different, and investors have likely moved past most of last year’s hot-button issues.

So it seems unlikely to us that this conflict will hit sentiment as hard as Ukraine did. This could change, if more nations get sucked in, but that outcome seems fairly distant to us at this point. Other regional powers are quiet. We have seen talk of attacks stemming from Lebanon, Iran and others leading to a broader war, but that is mere speculation and those players, too, are quite small economically.^[xi] The fog of war is thick, but so far, the likelihood of fighting spreading beyond the region looks quite low to us.

Therefore, we encourage investors seeking long-term growth to stay cool. Focus on your long-term goals and remember that getting the returns needed to reach them requires being invested in bull markets. Again, we think 2022 was the exception, not the norm, when it comes to markets dealing with regional conflict, and in our view, investing successfully is about probabilities—not possibilities. History shows us stocks have a high probability of overcoming regional strife quickly, including in the Middle East.