Iran, Geopolitical Conflicts, & the Markets

On Friday, February 27th, the S&P 500 closed down about half a percent from the previous day’s close. I was out of the office that day, as I joined Carter, Robyn, and Aunt Libby on a trip to the State Farm Arena in Atlanta to see the K-Pop band Twice perform. Libby, the musical connoisseur and concert-going enforcer of the family, had to be included. I think every concert Carter has attended thus far has been with Aunt Libby. I checked in on the market throughout the day, and remember it being thankfully uneventful.

Of course, on Saturday morning, we all woke up to the news of the attack on Iran. I read a few of the articles while everyone else slept, and although surprised, I wasn’t too surprised. The U.S. had been positioning military units in the area for a month, and plenty of headlines had already been broaching what an attack would look like and could entail. But it was still big news, and since then, over the course of one week, the media with its doom and gloom and scrolling capital letters with flashing red blocking has been hard at work offering all the best worst-case scenarios that can be imagined, including in terms of the stock markets.
 
Much of the market volatility we are experiencing stems from uncertainty about whether the situation will continue to escalate and worsen. Emotions elicited by uncertainty are the best fuel to keep the fear-mongering media firing on all cylinders. However, if we look past the shock-inducing headlines and focus on the heart of the uncertainty, we can identify a few specific issues that economists and money managers are looking for before they become genuinely concerned about a lasting impact on the stock market. Those issues are inflation and recession, and in this case they are very closely related. They are also linked by a common factor, oil prices.
 
But before we get into that, let me share a very brief review of past geopolitical shock events and their influence on the stock market here in the United States. These findings come from research that LPL has done and continues to update. LPL analyzed the effects of 25 major shocks since World War II, including the attack on Pearl Harbor, the Cuban Missile Crisis, the Reagan Shooting, U.S. Terrorist Attacks, and the escalation of the Russia/Ukraine Conflict. The average 1-day decline from these events is (1.1%), the average total decline before the market reclaims lost ground is (4.7%), and the average time of recovery is 41.4 days. The average S&P 500 return for the 3-month, 6-month, and 12-month time periods following these events is positive 3.1%, 6.3%, and 9.2% respectively. The U.S. stock market generally takes these geopolitical shocks in stride and moves on. But always, initially, there is a lot of fear and uncertainty.
 
The biggest worry today is that the increase in oil prices will cause enough long-lasting inflationary pressure that the economy goes into recession. During the first week after the attack on Iran, oil prices have increased close to 40%, with the possibility of further increases indicated throughout the weekend. This has led to an increase of about 30 cents at the gas pumps, and another possible 20 cents increase is anticipated, with oil prices climbing past $100 a barrel.
 
Common sense tells us that higher oil and gas prices are a big inflationary factor. They are a cost that both consumers and businesses must take on, and this directly hurts everyone’s bottom line. And now, when times are as tight as they are for so many citizens, it will make it much harder for many to make ends meet. However, as you have likely heard, the U.S. economy is currently “K-shaped,” with high wage earners continuing to increase discretionary income, while lower wage earners continue to lose spending capabilities. Although it may be unfair, the U.S. economy as a whole will not easily be stifled by these higher oil prices. The highest income households, who contribute more than 50% of total consumer spending, will absorb the higher energy and gas prices and continue their current spending habits. And even though businesses will have to endure higher energy cost inputs, the U.S. has become the world’s largest producer of petroleum. Since 2020, we have been a total net exporter (we sell more to other countries than we buy) of petroleum. Ultimately, although not a full certainty, it is highly likely that the higher oil prices will be a net positive towards the country’s GDP, keeping us from falling into recession.
 
I know emotions are running high and the headlines can be frightening. For now, as long as there is no further escalation beyond what is already expected, the markets will hopefully follow past patterns of response to geopolitical shocks, and the current spike in oil prices will not be too problematic for the still strong economy of the United States.
 
Please remember we welcome your calls and visits anytime.
 
Sincerely,
 
Justin Anderson