The recently initiated conflict in Iran, it appears, will continue at least in the near-term. The effects of the clash will carry well past its end, whenever that is, as many oil producing countries in the Middle East are forced to shut down production. Storage facilities are full due to the lack of access to waterborne transportation and there is simply no place to put any more. It will take time for the supply chain blockage to dislodge. Since the onset of the conflict, West Texas Intermediate (WTI) oil prices are up 40% (in a week) to $91.27, as of Friday’s market close.
In the immediate aftermath of the U.S. incursion, U.S. markets attempted to shrug off the news. Investors may have presumed that the military actions were designed similarly to the rapid removal of former President Nicolas Maduro in Venezuela, and a quick end to conflict. Or they may have looked past the short-term disruption toward the usual and eventual period where U.S. investors tire of focusing on global conflicts on the other side of the world. It could have been that they expected the Administration to bore of the conflict and move on from it quickly. All potentially reasonable conclusions given prior experiences. Whatever the early sanguinity derived from, it appears now that the conflict will remain a driver of markets over the coming weeks and months.
War is a human tragedy with human costs that are far greater than the monetary price markets pay. We are market participants and commentators, however, and we thus weigh those impacts. In those terms, international markets have been the more direct casualty from a stock perspective. Having started the year with the best relative performance since 1988, international stocks are down 7% (as measured by the MSCI EAFE index) to 8% (as measured by the MSCI Emerging Markets Index) this week versus the 2% decline for the S&P 500. War has done this year what tariffs didn’t last – strengthen the dollar, impinge international access to key inputs and supply chains, and weigh on international markets more than domestic ones.
Fixed income markets are in a quandary in the wake of the conflict. Historically, conflict like this would pressure global financial capital into “safe havens” like U.S. Treasury bonds. This time, however, bonds were already at the low end of their technical range when war broke out, and investors now must grapple with the potential inflationary impacts of higher oil prices in an environment wherein the jury remains out on whether underlying inflation was whipped. Even Friday morning’s decline in jobs is being overlooked to an extent. As a result, 10-year treasury rates are up 17 basis points to 4.13% on the week. Two-year rates are up 16 basis points to 3.55%.
The situation in Iran remains uncertain and rapidly changing. But hopes that it meant “nothing” for markets seem dashed. From our perspective, we believe that diversification benefits will remain intact during this period, much as they have for the last six months. Volatility in stocks and bonds is likely to remain elevated in the near-term. As always, while uncomfortable in the moment, this volatility also unlocks opportunities that may have been unavailable during calmer periods.
There have been multiple statements about the reasoning and strategy for the initiation of conflict in Iran. We aren’t military strategists, so our opinion here is of little value, but coupled with other recent U.S. military activity, it seems that there is at least some intent to affect China. Whatever the reasons for bombing, our positive viewpoint on international stocks is likely to face additional internal debate given the uncertainty of supply chains. The support from more attractive relative valuation, increased fiscal impulse internationally, and diversification momentum of asset allocators remains. Discussions about whether those benefits can be offset will take place.
Finally, the ongoing and internal market debates about the impacts of A.I. on the durability of various subsegments of the Technology sector will continue as well. Diversification, emphasis on quality (even though junk has rallied since September), and attention to valuation will remain our guideposts in these considerations.
As always, should you have any questions, or would like to discuss these or other topics further, please do not hesitate to reach out.