Unlock Editor’s Digest Lock for Free
FT editor Roula Khalaf will select your favorite stories in this weekly newsletter.
Observers may be allowed to think that financial markets don’t care much about geopolitical shocks. The world’s largest economy is threatening to place itself behind a tariff wall. War is raging in Europe. And since June 13th, a fresh Middle Eastern conflict has erupted. However, the S&P 500 remains near record highs. Even if the US was thinking of taking part in Israel’s war with Iran, it was resilient this week. Brent’s oil prices are rising, but tame at $77 per barrel. Have investors lost contact with reality? Looking at historic market response to global events suggests that this is not the case.
Using data dating back to World War II, Deutsche Bank found, on average, the S&P 500 tends to drop by about 6% in three weeks after a geopolitical shock. In other words, if history is the guide, there is still time for market responses to the Israeli-Iran conflict to evolve.
Also, each shock appears in a variety of ways. Adolf Hitler’s annexation of Czechoslovakia in 1939 caused a 20% crash on major US equity indexes. It took me over a month. The 9/11 attack caused more than 10% sales in just six days, and recovered in three weeks. The 1973 oil embargo by Arab countries following the Yom Kipper War caused an inflation crisis that took years for developed markets to recover. Europe’s reliance on Russia’s gas meant that the industry was long hampered by high costs after Vladimir Putin’s invasion of Ukraine in February 2022.
What can we learn from these events? Market reactions usually reside in two parts. First, the confidence of Shock Buffet investors has taken away their flight to safety. Second, depending on the economic significance and sustainability of the event, it will ultimately penetrate revenue, investment plans, prices and employment, leading traders to the price of changes in economic outlook.
Investors currently facing shocks from both tariffs and the Middle East are trying to see the impact on the real economy. The sharp early sale caused by Donald Trump’s “liberation day” obligations remained only by a 90-day suspension in its execution. That deadline ends on July 8th, and it is little clear what will happen next.
When it comes to the Israeli-Iran war, a more restrained, immediate response makes sense, at least compared to the historical energy shock. Oil is no less important in powering the world economy than in the 1970s. The supply is not concentrated either. Iran’s oil exports account for less than 2% of global demand, and in 2020 the US became the first annual net exporter of total oil since at least 1949.
This has focused investors’ minds on what is most important to the global economy from the crisis. The biggest risk is escalation, potentially entering the conflict with the US leading to the closure of the Strait of Hormuz, which flows into a fifth of the world’s daily oil consumption. If that happens, analysts believe oil can push more than $120 per barrel. A temporary price shock could turn into more persistent inflation that affects knock-ons to central banks.
This allows traders to carefully look at both tariff and Middle East War developments and readjust the odds of worst-case scenarios in real time. Only when uncertainty is resolved can investors properly reevaluate the forecasts of the economic foundations that underpin the valuation of their assets. However, for now, July 9th remains a big unknown. And while President Trump appeared to allow time to negotiate with Iran on Thursday, he warned earlier that “no one knows what I’m trying to do.” Despite its recent advent, geopolitics is immediately important to the market as soon as it affects the real economy. Today may prove relatively calm before the storm.
