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Financial markets may seem unaffected by geopolitical upheavals. Despite the threat of imposing tariffs, ongoing wars in Europe, and the recent conflict in the Middle East, the S&P 500 continues to hover near record highs. Even as the US contemplates joining Israel’s war against Iran, the S&P 500 has shown resilience this week. While Brent crude prices have seen a slight increase to $77 per barrel, investors seem disconnected from reality. However, historical data on market reactions to global events indicates otherwise.
According to Deutsche Bank’s analysis of data dating back to World War II, the S&P 500 typically experiences a 6% drop in the three weeks following a geopolitical shock, only to fully recover three weeks later. Therefore, based on historical trends, there is still room for the market’s response to the Israel-Iran conflict to evolve.
Each geopolitical event has a unique impact. For instance, Adolf Hitler’s annexation of Czechoslovakia in 1939 led to a 20% crash in the main US equity index, which took over a month to recover. The 9/11 attacks triggered a more than 10% sell-off in just six days, but it rebounded within three weeks. The 1973 oil embargo following the Yom Kippur war resulted in an inflation crisis that took years for developed markets to recover from. Similarly, Europe’s reliance on Russian gas caused prolonged economic challenges after Vladimir Putin’s invasion of Ukraine in February 2022, with Germany’s Dax index continuing to decline until October of that year.
These events demonstrate a two-part market reaction. Initially, investor confidence is shaken, leading to a flight to safety. Subsequently, depending on the event’s economic impact and duration, it starts affecting earnings, investments, prices, and employment, prompting traders to adjust to a new economic landscape.
Currently, investors are evaluating the impact of both the tariff threats and the Middle East conflict on the real economy. The initial market dip caused by Trump’s tariff announcements was temporarily halted by a 90-day suspension of enforcement, which is set to expire on July 8 with no clear resolution in sight.
Concerning the Israel-Iran conflict, the relatively muted immediate response, especially regarding energy shocks, is rational. Oil plays a lesser role in the global economy than in the 1970s, with a more diversified supply chain. Iran’s oil exports represent less than 2% of global demand, and the US has become a net exporter of petroleum since 2020.
Investors are now focused on the crisis’s potential impact on the global economy. The primary concern is an escalation leading to the closure of the Strait of Hormuz, through which a significant portion of global oil flows. If this occurs, analysts predict oil prices could exceed $120 per barrel, potentially causing sustained inflation and impacting central banks.
Market participants are closely monitoring developments in both the tariff negotiations and the Middle East conflict, adjusting their risk assessments in real-time. Clarity on these issues is necessary for investors to reassess their economic projections and asset valuations. However, the uncertainty surrounding July 9 looms large, as Trump’s stance on Iran remains unclear. Despite recent market stability, geopolitics can significantly impact markets once it affects the real economy. Today may just be the calm before the storm.