After the US killing of Qassim Suleimani on Jan. 3 and Iran’s retaliatory, non-lethal missile strike against two US military facilities in Iraq on Jan. 7, the situation appears to have de-escalated. However, investors continue to worry about the potential for this conflict between the US and Iran to worsen. We do not believe that a war is likely at this juncture, but it is important to understand the potential effects that such a worst-case scenario could have on the markets.
War has usually led to a bear market …
Historically, serious military conflict has been one of the more reliable triggers for an equity bear market in the past hundred years. Our team has analyzed various factors that have contributed to bear markets since 1915,1 and there has been a high historical correlation with times of war. There were 28 equity bear markets between 1915 and 2018. War wasn’t a factor in all of them (only about 30%). But, when war was happening in the world, a bear market followed about 80% of the time — higher than other factors such as recession, rising unemployment, an inverted yield curve, and rising inflation. In other words, war isn’t a necessary condition for a bear market, but it has historically been enough to trigger one.
This has been especially so for conflicts in the Middle East that threaten oil supplies (a sharp rise in oil price affects business and consumer spending, compounding the economic damage). A case in point is the Yom Kippur War of 1973, which resulted in a major rise in the price of oil and a crushing of the global economy and stock markets.
… but stocks have tended to rebound relatively quickly
However, there is more to the story. In a similar analysis, we looked at equity performance for six of the wars during this timeframe (World War I, World War II, the Cuban Missile Crisis, the Yom Kippur War, the Kuwait War and the Iraq War).2 We found that the US stock market typically bottomed within 12 months of the tension becoming apparent (which was usually before the outbreak of war), and, most importantly, typically returned to its pre-conflict level within 18 months.2
Additionally, we think it is worth pointing out that the world today is not as dependent upon Middle Eastern oil for energy as it has historically been, given the dramatic increase in oil production from the US. What’s more, the global economy is less dependent on oil in general — it is just less energy intensive than it was just a few decades ago. That could also mitigate any negative economic effects resulting from a major conflict between the US and Iran.
What could continued US-Iran conflict mean for investors?
And so, as news flow around the US-Iran conflict continues, we should be prepared for the possibility that the situation may worsen. If it does, we would expect to see an impact on various asset classes. In our view:
- A sell-off in risk assets would be likely, especially the stocks of energy-intensive companies and markets in the Middle East.
- We would likely see “safe haven” asset classes such as gold, Japanese yen, Swiss franc, and US Treasuries perform well.
- Although the world is less energy-dependent on the Middle East, we would still expect to see a significant rise in the price of oil (and related energy commodities) and relative outperformance of sectors such as oil & gas and utilities (many of which have tariffs related to wholesale energy prices).
- Among factors, we would expect low volatility stocks to outperform during periods of risk aversion.
- Among emerging markets, energy users (such as China and India) would likely underperform non Middle East energy producers (such as Russia and Mexico). The Russian stock market has been cheap (with dividend yield exceeding price-to-earnings ratios) and is heavily weighted in energy sectors, suggesting significant potential to benefit.
- The Russian ruble and Mexican peso could also benefit for the reasons mentioned in the previous bullet point.
- Finally, we could see US high yield bonds holding their ground. This asset class could be hurt by heightened risk-aversion, but it has a significant weighting in the energy sector, which could help it.
It is worth noting that the Federal Reserve has a very accommodative stance, as do many major central banks. That should help render any risk asset sell-offs shorter and shallower.
In summary, we suspect tensions between the Iran and the US will continue but remain contained, and we believe an actual war is highly unlikely at the moment. However, it’s always good for investors to be prepared. Thus, it’s important to remember both the market implications of past wars and Middle East conflicts, as well as the ways in which the world has changed since then.
With contributions from Tomo Kinoshita, Global Market Strategist for Japan.
1. Based on the 28 years from 1915 to 2018 when US equity total returns were negative or when equities ranked among the bottom third of assets. We calculated a total return index for broad US stocks based on index and dividend data from US academic Robert Shiller and Datastream. Equities prior to 1926 represented by Shiller’s recalculation of data from “Common-Stock Indexes,” 2nd Edition, published by Cowles & Associates in 1939. From 1926 to 1957, the Shiller data is based on the S&P Composite Index and thereafter is based on the S&P 500 Index as we know it today. The following wars were used in the analysis: WWI, WWII, Korean War, Suez Crisis, Cuban Missile Crisis, Vietnam War, Yom Kippur War, Iraq invasion of Kuwait, and allied invasion of Iraq.
2 Sources: Robert Shiller and Invesco analysis. Based on the monthly performance of the US equity market (as defined in Footnote 1) from the onset of tension leading up to the following events: WWI (July 28, 1914, to Nov. 11, 1918), WWII (Sept. 1, 1939, to Sept. 2, 1945), Cuban Missile Crisis (Oct. 16, 1962, to Oct. 28, 1962), Yom Kippur War (Oct. 6, 1973, to Oct. 26, 1973), Kuwait War (Aug. 2, 1990, to Feb. 28, 1991) and the Iraq War (March 20, 2003, to Dec. 18, 2011). An investment cannot be made directly into an index. Past performance is not a guarantee of future results. There are no guarantees that the historical performance of an investment, portfolio, or asset class will have a direct correlation with its future performance.
Blog header image: Bisual Studio/Stocksy
The yield curve plots interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates. In a normal yield curve, longer-term bonds have a higher yield. An inverted yield curve is one in which shorter-term bonds have a higher yield than longer-term bonds of the same credit quality.
Safe havens are investments that are expected to hold or increase their value in volatile markets.
Factor investing is an investment strategy in which securities are chosen based on certain characteristics and attributes. Low volatility describes investments that consistently demonstrated lower volatility than securities in the same asset class. Low volatility cannot be guaranteed.
Risk assets are generally described as any financial security or instrument, such as equities, high-yield bonds, and other financial products that carry risk and are likely to fluctuate in price.
All investing involves risk, including the risk of loss
The opinions referenced above are those of the authors as of Jan. 13, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.