Table of Contents
Escalation of the Iran-Israel Conflict: Market Implications
The recent intensification of the Iran-Israel conflict over the past few days has captured global attention, with both nations amplifying their military operations. This escalation has triggered a surge in oil and gold prices, driven by concerns of interrupted Iranian energy production and a heightened demand for safe investments. Despite this, the S&P/ASX 200 index displayed relative stability on Monday.
The Australian sharemarket’s steadiness contrasts sharply with the international anxiety surrounding the conflict, which raises fears of a prolonged regional war. Global bodies, including the UN, G7 leaders, and French President Emmanuel Macron, have called for restraint, while Russia has condemned Israel’s military actions as violations of international law.
Iran’s Supreme Leader Ayatollah Ali Khamenei has promised a "harsh response" alongside military leaders’ pledges of ongoing retaliation. Israeli Prime Minister Benjamin Netanyahu has characterised the military response as crucial for the preservation of Israel, alluding to the potential for regime change in Iran.
Historical Context: Market Reactions to Geopolitical Tensions
The historical performance of the S&P/ASX 200 during significant geopolitical events reveals a tendency for short-term dips followed by a market recovery within a month. Research shows that while such conflicts often trigger immediate downward pressure on equities, the long-term impact is typically minimal.
Economic State Matters
The influence of the broader economic context on post-conflict returns is substantial. Out of ten major conflicts analysed, three coincided with recessions or triggered economic downturns:
-
The Iraq-Kuwait War (1990): Oil prices soared from US$15 to US$40, leading to an economic contraction of 1.5% and unemployment peaking at 7.8% in 1992.
-
September 11 Attacks (2001): This event worsened the existing dot-com recession, exacerbating economic challenges.
- The Iranian airstrike (2020): Although not occurring during a recession, it preceded the economic disruption wrought by the pandemic.
When the US economy is in recession, the ASX 200 tends to show negative average forward returns. In contrast, periods of economic growth generally correlate with strong positive returns.
Current Risks and Market Outlook
While historical patterns suggest that geopolitical tensions typically subside after a month, the current situation poses unique challenges. The apparent unwillingness of both Iran and Israel to de-escalate has raised the spectre of a wider regional conflict, with the potential involvement of the US and other global powers.
In recent trading sessions, oil prices have surged by about 12%, with Brent crude nearing US$74.70 per barrel—the highest level since late February. This price increase comes at a critical time as inflation rates are returning to central bank targets of 2-3%. A significant rise in oil prices could impact consumer inflation and compel central banks to revisit their easing plans, thus highlighting the conflict’s implications for monetary policy.
This escalation occurs as the ASX 200 has recently experienced a substantial V-shaped recovery of approximately 17% from the lows following Liberation Day and is now trading at unprecedented levels, which may make the market susceptible to corrections or profit-taking.
Recent history offers insight into potential outcomes. Nine months ago, a similar escalation unfolded between Iran and Israel. Although it initially hampered market performance and raised the S&P 500 VIX from 15 to the low 20s, the adverse effects were temporary, aligning with historical observations. By November, the turmoil had largely dissipated.
Conclusion: Navigating Geopolitical Challenges
In summary, each geopolitical event warrants due respect and vigilance from investors. However, historical trends suggest that market overreactions may present opportunities for those with a long-term investment perspective. The resilience of the ASX 200 amid current geopolitical tensions provides a glimmer of hope for investors, but the evolving situation necessitates careful consideration of both immediate risks and historical precedents.
