- US and Iran tensions intensified last week. US stock markets reacted to the tension. The S&P 500 and the Dow Jones Index closed in the red on January 3.
- Do stock market investors really need to worry about US and Iran tensions?
US and Iran tensions and stock markets
US and Iran haven’t had the best of relations for more than four decades. After a brief lull following the Iran nuclear deal under the Obama administration, the countries are back to square one. Last year, President Trump pulled the US out of the Iran nuclear deal. US sanctions on Iran’s oil exports have crippled the Iranian economy. Last week, the tensions flared up between the two countries. A US-led drone strike killed General Qasem Soleimani in Baghdad. The strike came after a US contractor was killed in Kirkuk. The US said that the strike was pre-emptive. Iran has vowed to retaliate. However, President Trump has warned Iran not to strike back. What will the tensions mean for US stock market investors?
Oil prices rise
Any geopolitical tension in the Middle East leads to a short-term spike in oil prices. Last year, oil prices spiked after the attack on Saudi Aramco facilities. The attack came before Aramco’s IPO. However, Aramco’s IPO went through and the company is now the largest publicly-traded company. Aramco passed Apple (AAPL) and Microsoft (MSFT). After the US and Iran tensions increased, crude oil rose to the highest level since April 2019. Any rise in oil prices is usually negative for the global economy. Higher fuel prices lead to lower disposable income for consumers.
However, crude oil prices might not rise much. First, US shale production can offset any fall in production in the Middle East. Saudi Arabia and other OPEC+ countries can also help. Second, the demand side of the equation isn’t that strong looking at moderating global growth. While there could be a modest rise in crude oil prices, it might not shake the global economy.
Could US stock markets react?
According to a CNBC report, “Crude prices see a positive change more than 80% of the time in the month following major events. Gold and stocks followed as the next most successful asset classes.” The analysis is based on “20 crisis events in the Middle East over the last three decades, including the attacks on oil facilities in Saudi Arabia last September.” How US stock markets react to US and Iran tensions this time will eventually boil down to the escalation matrix in the current conflict. President Trump already warned Iran about heavy consequences. If the tensions escalate, it might pressurize the US and global equity market.
Last year, I noted that geopolitical tensions are among the biggest risks for stock markets in 2020. Given the looming US presidential election, President Trump might react strongly to any escalation from Iran. That said, his action against Iran would galvanize his supporters. President Trump can claim some sort of victory with the USMCA and phase one of the trade deal with China. Action against Iran could be another talking point in his 2020 campaign.
From trade war to real war?
Interestingly, 2018 started with tariffs on washing machines from South Korea and solar panels from China. President Trump followed up by approving the Section 232 steel and aluminum tariffs in March. Then we had the trade war with China. Both of the countries imposed tariffs on billions of dollars of goods. US stock markets came under pressure whenever there was an escalation in the US and China trade war.
In 2019, Canada, Mexico, and the US signed the USMCA for the second time. The countries also agreed to phase one of the trade deal. The deal will likely be signed this month. Phase one of the US and China trade deal supported the rally in US stock markets last month.
Stock markets and the Trump effect
In 2018, what started as normal tariffs escalated into a full-blown trade war. The trade war had a negative impact on both countries’ economic activity. Notably, 2020 started with an escalation in US and Iran tensions. We’ll have to see how far the current tensions escalate. However, if the tensions increase, it could impact stock markets. The tensions with Iran won’t really hurt President Trump’s reelection chances. With an economy that’s still resilient and stock markets at record highs, a dose of nationalism will only add to President Trump’s appeal. Some observers think that US stock markets’ 2019 returns were due to President Trump.
Some bearish analysts expect a market crash in 2020. However, pessimists predicted a market crash in 2019 as well. Instead, US stock markets rose to fresh records.