As the world awaits a possible retaliatory strike by Israel against Iran in response to Tehran’s missile and drone attack over the weekend, asset managers and other experts worry over the potential for a wider conflagration in the Middle East and how such an escalation may impact global markets and the chances for a soft landing for the U.S. economy.
Melissa Brown, managing director of applied research at SimCorp, said global markets have been “remarkably complacent” about two simultaneous wars — in Ukraine and Gaza — until now.
“However, Iran’s seeming entry into the conflict sows seeds of concern that the war, and damage, could widen,” she said. “I think Israeli retaliation will raise the stakes and emphasize the difficulty in keeping (the) war contained.”
SimCorp, a subsidiary of Deutsche Boerse Group, is a risk-management software provider for investment management firms.
Emily Bowersock Hill, CEO and founding partner of Bowersock Capital Partners, with $935 million in assets under management, said that current geopolitical risks are “unusually elevated and are likely to remain so.”
“The risk of an expanded conflict in the Middle East that could significantly diminish the odds of an (economic) soft landing is higher than investors appreciate,” she added.
On April 13, the Iranian military launched more than 300 drones and missiles at Israel in an unprecedented attack allegedly in response to Israel’s targeting of the Iranian consulate in Damascus, Syria, two weeks ago that killed several Iranian military leaders, including Brigadier General Mohammad Reza Zahedi.
However, Israel said on April 14 that almost all the projectiles from Iran had been intercepted without much harm. Israeli army spokesman, Rear Admiral Daniel Hagari posted on X (formerly Twitter): “The Air Force, together with the strategic partner countries, successfully intercepted dozens of aerial threats launched from Iran towards Israel,” adding that “out of hundreds of launches, only a few rockets penetrated the territory of the State of Israel and caused only minor damage.”
Mark Heppenstall, president and chief investment office, Penn Mutual Asset Management, noted that Israel’s successful air defense against the Iranian attack “offers some hope Saturday’s events may not lead to a wider conflict in the Middle East.” Penn Mutual has $35.1 billion in AUM.
For now, global markets have heaved a sigh of relief that Israel was able to almost entirely quell the Iranian attack.
James Demmert, chief investment officer at Main Street Research, with $2 billion in AUM, noted that stock market reactions to past geopolitical conflicts have been nuanced depending on the severity of the conflict.
“As of today, market volatility has been somewhat muted as we await a response from Israel,” he said. “We expect further volatility as negotiations among the G-7 and Israel proceed.”
In some sense, Brown noted, investors had been “generally cautious” already, mostly buying cheaper, less volatile stocks — along with technology issues — but overall they have remained invested in equities.
Hill also said that historically, geopolitical shocks have caused short-term volatility, not long-term market declines.
“In this current environment, however, the risk of an extended period of volatility is higher, given the inflationary oil price shocks that may emanate from the heightened tensions in the Middle East,” she stated. “Geopolitical risks are not limited to the Middle East, as the Russia/Ukraine war and rising trade tensions with China threaten to further fragment supply chains and fan inflation.”
But If Israel retaliates — against the wishes of the U.S. — it risks a serious escalation of the war, which can have more significant repercussions for global equities, Demmert warned. For instance, he noted, during the outbreak of World War I in 1914, the S&P 500 index dropped by 18% in just three months. World War II had an even more significant impact, with the index dropping by 30% in the year following the start of the war. The Gulf War, which began in 1990, also had a negative impact on the market, with the index dropping by 15% in the first few months following the outbreak of the conflict.
In the event of a widening conflict between Iran and Israel, Brown said oil prices and stocks “for sure” will be impacted. “Equities in general could fall and corporate bond spreads widen,” she noted. “Defense stocks are likely to benefit. Inflation may continue to be stubbornly high.”
Brown recommends that institutional investors make sure they understand the risks in their portfolios by stress-testing various negative scenarios — e.g. higher interest rates and higher oil prices — and rebalancing or hedging if potential losses are more than the portfolio can bear.
