Global markets experienced a sharp risk-off reaction at the start of the week due to escalating Middle East conflicts, leading to declines in stock markets, while gold, crude oil, and the U.S. dollar all moved higher.
However, a closer look reveals significant divergence within the market. Certain sectors bucked the downtrend, such as major energy companies and defense contractors. Palantir, a software firm providing services to the U.S. military, was one of the few tech stocks showing gains in pre-market trading.
Simultaneously, prices of benchmark U.S. government bonds fell, pushing yields higher, as concerns about rising inflation stemming from the surge in oil prices offset some of the safe-haven demand.
Mike Wilson, Chief U.S. Equity Strategist at Morgan Stanley, believes oil prices will determine whether this round of geopolitical panic triggers a more damaging correction in the stock market. "Historically, geopolitical risk events have not led to sustained volatility in equity markets," Wilson stated in a report issued on Monday.
Data analysis shows that one month, six months, and twelve months after a geopolitical event, the S&P 500 index has historically averaged gains of 2%, 6%, and 8% respectively.
To date, the most severe impact on 12-month stock market performance followed the 1973 Yom Kippur War, where an oil supply crisis directly triggered an economic recession.
Therefore, Wilson pointed out, "If the recent events involving Iran and the broader Middle East lead to a significant and sustained rise in oil prices, thereby threatening the duration of the economic cycle, a more pessimistic scenario for equities could unfold."
He stated that history shows that for an oil price spike to cause such severe damage, two conditions must be met: a year-over-year price increase of 75% to 100%, and for this surge to occur during the late stage of an economic growth cycle.
He believes these conditions are not currently met: "As we have previously stated, we believe the market is in the early stages of a cycle characterized by accelerating earnings recovery."
Furthermore, at the time of his report, the year-over-year increase in crude oil prices was only modestly positive, at approximately 5%.
"Consequently, unless we witness a historic oil price spike that is sustained, recent events are unlikely to alter our optimistic outlook for U.S. equities over the next 6 to 12 months," Wilson said.
With improving corporate earnings and an economy expected to gain momentum, his year-end target for the S&P 500 remains 7800 points. For investors maintaining caution, his most favored defensive sector is healthcare, which is attracting more investor interest due to its low valuations, improving profitability, and reduced policy pressure.
Conversely, Lori Calvasina, a strategist at RBC Capital Markets, cautioned against over-reliance on historical precedent and simply recommending "buying the dip" on geopolitical bad news. While the bullish view may be "statistically correct," she noted that this perspective is based on conflicts of a "more limited scale."
"When it comes to the stock market, it's difficult to view geopolitical events in isolation. Geopolitical tensions are usually just one part of a larger narrative," Calvasina said.
U.S. markets were set for their first trading session on Monday following the escalation of regional conflict over the weekend after reported U.S. and Israeli strikes on Iran. The S&P 500's performance year-to-date has already been challenging, lagging behind international markets amid concerns about the impact of AI and policies from the previous administration.
On Monday, oil prices recorded their largest single-day gain in four years as traders assessed the impact of the effective closure of the Strait of Hormuz and the shutdown of a major Saudi Arabian refinery. European stock markets suffered their worst decline since last November, led lower by travel, retail, and luxury goods sectors. Asian markets also experienced significant losses.