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MarketScape · 10.16.23

How an Escalation of War in Israel May Impact Markets

Beyond the considerable human toll the war in Israel has already taken, an escalation of the conflict could disrupt the world’s energy supply, damage global economic growth and spark market volatility. Chief Investment Strategist for EMEA and APAC Wouter Sturkenboom, CFA, outlines some scenarios.

  • Markets & Economy
  • Market Views
  • Commentary
Wouter Sturkenboom, CFA
Chief Investment Strategist – EMEA and APAC

Key Points

What this is

We analyze how the war in Israel and Gaza could impact investors.

Why it matters

If other Middle East countries such as Iran engage, oil prices may spike globally.

Where it's going

Higher oil prices could damage global economic growth and spur equity volatility.

After a period of relative stability in the Middle East, war has returned to the region with the Hamas attack on Israel. The conflict has taken an considerable human toll, and we see no sign that fighting will end soon. From an economic and market perspective, we think the primary concern is whether the war escalates, potentially to a military conflict between Iran and Israel. Escalation could disrupt the world’s energy supply, damage global economic growth and spark market volatility. Let’s take a closer look.

 

Early press reports are mixed in terms of Iran’s previous knowledge of or coordination with the attack. If Iran is linked to the attack, we believe that increases Iran’s likelihood of joining the conflict, which may drive oil prices higher. The extent of Iran’s involvement in the attack, if at all, likely determines how much additional military support the U.S. provides to Israel. If no evidence of Iran’s participation emerges, we expect the risk of escalation will fall. Since this evidence hasn’t appeared yet, much of the initial oil price gains since the attack has fallen off and the broad market reaction has been muted.

 

We expect investors to monitor developments for signs of escalation, given the potential for the war to disrupt the global oil supply and cause prices to rise. A significant surge in oil prices could threaten already slowing global economic growth. Direct conflict between Israel and Iran could take out as much as 2 million barrels a day of Iranian oil, or 2% of global supply. More importantly, Iran may try to block the Strait of Hormuz, through which 20% of global oil supply moves. In the event the war does broaden to significantly disrupt the flow of oil, estimates suggest oil could go to as high as from about $85 now. Historically, consumer demand tends to fall when oil reaches $120 a barrel, acting as a potential cap on prices in the intermediate term. A spike well above that level, combined with lower oil supplies, likely would hurt economic growth and equity markets.

 

An escalation of the war could damage global growth and spur equity volatility while higher oil prices may benefit commodity markets. In our global model, we have been underweight global equities and overweight natural resources. While we didn’t design this positioning to anticipate the economic consequences of global political risks such as this, we believe it can still offer some insulation from the risks of the war escalating.

Main Point

Potential for Economic Damage and Market Volatility

An escalation of the war could ignite higher oil prices, damage global growth and spur equity volatility. Investors may want to consider how these risks could affect their portfolios.

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