Will the Middle East crisis spark market turmoil?
If the current conflict does not disrupt global oil shipments or supply in any significant way, investor fears could eventually subside
MILITARY conflict between Israel and Iran escalated over the weekend, and markets are bracing for further signals from the Middle East and Washington that will shape the market outlook in the week ahead.
Stocks slid, bonds were volatile, and gold rose by 1.5 per cent on Friday (Jun 13), but there was no panic and stampede. The S&P 500 fell by just over 1 per cent last Friday and finished the week down modestly. It remains less than 3 per cent below its record high.
Here are some thoughts on thoughts on the latest Middle East conflict and its market impact.
Concern over a potentially wider conflict
This is the first time that Israel and Iran have exchanged fire with such intensity. The two have been bitter enemies for decades, but so far, most of the conflict between them has been fought indirectly through Iranian proxies such as Hamas and Hizbollah. Israel had threatened many times to attack Iran’s nuclear facilities, but it has never done so officially, and not on the overt and significant scale that we saw last Friday.
This clearly surprised the Iranians and many global leaders. Israel’s Prime Minister Netanyahu has said that it sees Iran as an existential threat, and warned that Israel will take as many days as necessary to remove the threat posed by Iran. This seems to suggest that Israel is prepared for a prolonged war with Iran until it is satisfied that Iran is no longer a military and nuclear threat. It adopted the same approach in recent months in extended conflicts with Hamas and Hizbollah, eliminating its key leaders and military capabilities.
Israel now seems to have set its sights on Iran, which it sees as a key backer of Middle East militant groups, including Hamas and Hezbollah. Iranian leaders have seen how effectively Israel has incapacitated Hamas and Hezbollah, which explains why it has retaliated aggressively. The attacks by Iran and counterattacks by Israel could escalate sharply if the Iranian leadership believes that Israel could threaten the survival of the current Islamic regime that came into power following a revolution in 1979.
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There are also concerns that the crisis may go beyond Israel and Iran and spark a wider conflict in the Middle East, and even draw in other military superpowers such as the US, Europe, China and Russia.
Worries about oil
A key worry for markets is how this conflict will impact oil prices, which rose sharply last Friday. Fears have resurfaced that Iran could target one of the world’s most vital oil arteries – the Strait of Hormuz, which is a narrow passage linking the Persian Gulf with the Gulf of Oman and the Arabian Sea. An Iranian general said on Saturday that Teheran was assessing whether to close the strait.
Roughly 20 million barrels per day of oil and oil products pass through it, accounting for about 20 per cent of global oil shipments. Any move to block it could cause oil prices to spike further and fuel inflation concerns even more.
However, analysts are sceptical that Iran will do something as drastic as shutting the Strait of Hormuz. For one, Iran is likely to see a backlash from its largest oil customer and trading partner, China, which reportedly absorbs three-quarters of Iran’s oil exports. Iran has made such threats in the past – in 2011, 2012 and 2018 – but no action was taken.
Nevertheless, there is still the risk that Iran could launch attacks on oil tankers and place mines on the Strait of Hormuz to disrupt maritime traffic. However, the Iranians are probably also worried that such actions or any move to block the straits could elicit a strong response from the US naval fleet based in Bahrain. The Iranian regime will be wary of dragging a superpower such as the US into its conflict with Israel, as it knows that it will not be able to match up to the combined military might of the US and Israel.
The other worry for markets is whether the current conflict would disrupt the supply of Iranian oil if its energy facilities are destroyed in attacks. Iran said that its Shahran oil depot in Tehran was targeted in an Israeli attack, but the situation is under control. However, there have also been news reports that Iran has suspended production at one of its major gas fields in the southern Bushehr province after an Israeli attack caused a fire there. Incidentally, this is also the world’s biggest gas field.
It remains to be seen if Israel will launch further attacks on Iranian energy infrastructure, although this will probably earn the disapproval of the US, and more specifically President Donald Trump, who is in favour of lower oil prices. Higher oil prices could also be contained if the Organization of the Petroleum Exporting Countries – and especially Saudi Arabia – agrees to raise output. The US could also release supply from its strategic oil reserve.
What should investors do?
Historically, geopolitical events in the Middle East have not had a lasting impact on markets unless they cause an oil shock or severe economic damage. If the current conflict does not disrupt global oil shipments or supply in any significant way, market fears could eventually subside.
What may matter more for markets in the coming months is the US decision on reciprocal tariffs due by Jul 9, and the Aug 14 deadline for US-China trade negotiations. Trump’s tax and spending Bill and the US debt ceiling, expected to be reached sometime in August, are other worries that investors have.
Investors should prepare for more volatility in the coming days and possibly even weeks, given the ongoing Middle East conflict. However, the crisis on its own may not spell the end of the global equity bull market as long as it doesn’t result in sharply higher inflation and cause a global recession.
There is a lot of idle liquidity on the sidelines that could provide market support, should there be sharp pullbacks. Such pullbacks will offer an opportunity to buy or accumulate, rather than a reason to run for cover.
Markets have been very resilient this year despite tariff shocks, inflation fears and geopolitical concerns. While these events caused brief selloffs, stock prices rebounded afterwards, and the snapbacks have been relatively fast and sharp.
Still, there is scope for safe havens such as gold to continue rising as global uncertainties are likely to remain a fixture, and as global central banks continue to diversify away from their US dollar holdings towards gold. We see gold rising to US$3,900 an ounce over a 12-month horizon.
The writer is managing director, investment strategy, OCBC
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