On the Iran Conflict

Capping weeks of uncertainty, US and Israeli forces attacked military and political targets in Iran over the weekend. Iranian Supreme Leader Ayatollah Ali Khamenei was killed, and other political and military officials have reportedly also died. Iran retaliated with drone strikes on military bases, energy infrastructure, airports and other high-profile targets in several neighbors, including Saudi Arabia, Qatar, Bahrain, Kuwait and the UAE. War is always a terrible tragedy, and we feel for those affected by the destruction of lives and property. Yet as always when covering geopolitical events, we look through a narrow market-oriented lens, setting aside the major sociological and philosophical issues as well as partisan bias. And overwhelmingly, stock and commodity markets move on from regional conflict much faster than people expect. We doubt this time is different.

Usually, markets follow a standard path when dealing with regional conflict. In the runup, amid saber-rattling and rumors of war, you usually get heightened volatility. The initial bombs and bullets can add to this. But it generally doesn’t take long for markets to assess the conflict’s scope, weigh how much of global GDP it will affect, see life going on elsewhere, and resume pricing in continued global growth. We have seen this throughout both Iraq wars, Israel’s war with Hamas in Gaza, the Bosnian War, the civil war in Syria and many, many others. In modern market history, only World War II directly and solely caused a bear market. That was the only one big enough to disrupt a significant chunk of global economic activity.

Even in the one apparent exception, when Russia’s war in Ukraine contributed to 2022’s global bear market, that was less about the war than fears of related economic issues (sanctions and energy markets) colliding with other fears (Fed rate hikes, inflation, post-COVID supply chain chaos) to hit sentiment. That bear market was short and shallow and ended in October 2022, while the war sadly rages to this day. By then, oil had erased its post-invasion spike, falling from March 8, 2022’s high of $133.18 per barrel to well under $100.^[i]

This time, markets already appear hard at work parsing out the actual economic implications. The S&P 500 was basically flat Monday, but Asian and European markets had a rough go. In many Middle Eastern nations, stock markets normally operate on a Sunday through Thursday workweek. Saudi stocks fell in the four trading days before war broke out but stabilized Monday despite the attack on national oil producer Aramco’s infrastructure. Bahrain’s benchmark fell just slightly Sunday and Monday, but Qatar’s fell more than -4% Monday and the UAE suspended trading.^[ii] Kuwaiti stocks also fell Monday after being suspended Sunday.^[iii]

To us, it all makes sense in light of the main economic concern: global energy flows. The conflict is concentrated in an area that generates a lot of the world’s oil and natural gas, supplying Europe and Asia in particular. Hence, markets in the affected producers and customers are blinking.

Yet oil isn’t signaling major disruptions thus far. Despite perpetual concerns about conflict with Iran effectively closing the Strait of Hormuz to oil tanker traffic, Brent crude is up less than $5 per barrel at the moment.^[iv] That is a big one-day move, but it puts oil in the middle of its range over the past three years. We are basically seeing a repeat of last spring, when Brent rose from a low of $60.31 per barrel on May 7 to $78.70 on June 18 amid the run-up to and start of the US’s “Operation Midnight Hammer” strike on Iran’s nuclear assets.^[v] That spike was short-lived and nowhere close to 2022.

This time, Brent journeyed from its low of $60.61 on December 17 to just under $78 as we write.^[vi] Don’t rule out further volatility, but it seems markets remember—even if many people don’t—that the Strait didn’t choke oil markets or the global economy during Iran and Iraq’s long war in the 1980s. The waterway took heavy fire as the two countries sank hundreds of each other’s ships and tankers, but only 2% of oil shipments through the Strait were actually affected.^[vii] Yes, as much as one-third of daily seaborne oil flows through it daily, but markets and businesses are adaptable. Producers have some pipeline capacity to reroute shipments. The shipping industry adapted to Yemen’s Houthi rebels disrupting Red Sea traffic to and from the Suez Canal, and the disturbance there barely registered in prices. Not every oil price spike signals a looming shortage. Sometimes it is just sentiment—and that looks likely this time, to us.

Natural gas is more of a pain point, just as it was in 2022. Then, when Europe raced to replace Russian gas, benchmark European gas prices temporarily went through the roof on fears of wintertime shortages. The Continent got through it, opening more liquefied natural gas (LNG) import terminals to receive shipments from the US and, to a lesser degree, Qatar. Over the weekend, Qatar suspended natural gas production after attacks on its infrastructure, largely explaining the sharp drop in Qatari stocks. That seems to have resurrected supply shortage fears in Europe, which has now temporarily lost a supplier and may face more competition from Asian nations for US LNG in a prolonged Qatari shutdown. Dutch TTF gas prices, the European benchmark, rose almost 40% Monday.^[viii]

Yet here, too, context is key. In 2022, European gas hit a high of €339.20 per megawatt hour on August 26 as fear spiked amid concerns about low gas storage levels heading into the winter.^[ix] Today, we are heading out of winter, and European gas’s spike took it to just $44.51 per mwh.^[x] Instead of losing a major supplier full stop, as it did in 2022, Europe is facing the potential need to adjust supply. While Qatar doesn’t yet have an official timeline for bringing supply back online, industry analysts suspect it will be later this month. And given natural gas’s importance to Qatar’s economy, they have every incentive to move quickly and the expertise to accomplish that.

US natural gas prices don’t presently point to a major looming international shortage. If the world were about to lose a major source of LNG for the long haul, benchmark US prices (Henry Hub) would likely jump, registering the sharp increase in international demand. They did so in 2022, rising from $3.56 per million British thermal units (mmbtu) when that year began to over $9 that summer. Monday, they rose from $2.86 per mmbtu to $2.98.^[xi] US natural gas has also fallen over the past month despite blizzards and war fears. This is not how markets behave when they are discounting a supply shock.

So our advice now is simple: Take a deep breath, remember your long-term goals and don’t overreact to volatility. While fear hit European stocks Monday, we expect that reaction to prove fleeting, with this adding to their already relatively higher wall of worry. Europe’s chasm between dreary sentiment and reality was already wide and just got wider. As markets get over the initial jitters and resume weighing probabilities, this bull market should keep marching on.