The escalation of conflict in the Middle East has reintroduced a layer of geopolitical uncertainty that markets have not had to meaningfully price for some time. Given the region’s central role in global energy supply and trade routes, the implications are both immediate and far-reaching. While the situation remains fluid, it is important to assess the impact through a disciplined investment lens; separating short-term disruption from longer-term fundamentals.
What Does History Tell Us?
Historical patterns provide valuable context in assessing the market impact of geopolitical conflicts. While each event is unique, the market response tends to follow a consistent trajectory.
- In the immediate aftermath of geopolitical shocks, uncertainty typically leads to weaker returns, with equity markets delivering modest gains of around 0.3% over the following three months.
- Over longer horizons, returns tend to recover, with six- and twelve-month performance broadly in line with historical averages.
- Since World War II, the S&P 500 has been positive one year after the onset of major conflicts in approximately 70% of cases, including events such as the Gulf War, which also centred on the Middle East and had significant implications for oil markets.
This resilience reflects the tendency for markets to initially price in worst-case scenarios, before gradually refocusing on economic fundamentals as uncertainty begins to ease.
Attempting to reposition portfolios in response to rapidly evolving geopolitical events is inherently challenging and often counterproductive. A more robust approach remains maintaining diversification across asset classes, regions, and structural themes.
Chaos: What Is Driving Investor Concern?
- Energy markets have been the most immediate transmission channel. The Middle East accounts for roughly one-third of global oil supply, and any perceived threat to production or shipping routes; particularly through critical chokepoints such as the Strait of Hormuz, has pushed oil prices higher. This has reinforced inflation concerns at a time when central banks were already navigating a delicate path. Market expectations for US rate cuts have subsequently been scaled back from around two to closer to one this year, reflecting the inflationary implications of sustained energy price increases.
- Inflation uncertainty is complicating monetary policy. Higher energy prices risk delaying the disinflation process, particularly in energy-importing economies. However, it is important to recognise that central banks are unlikely to react to temporary supply shocks in isolation. Instead, they will assess whether second-round effects; such as wage pressures, become embedded.
- Regional market divergence has become more pronounced. Economies heavily reliant on Middle Eastern energy imports, including Japan and South Korea, have seen sharper equity market declines in response to rising oil prices and supply concerns. By contrast, the United States is relatively insulated given its status as a net energy exporter. While these divergences are significant in the short term, they have historically narrowed as global supply chains adjust and alternative sourcing is secured.
- The US dollar has strengthened as a safe haven. Despite periodic debate about its long-term dominance, the dollar continues to benefit from global risk aversion. Its role in energy pricing remains particularly important, as oil transactions are still overwhelmingly conducted in US dollars. This reinforces demand for dollar liquidity during periods of geopolitical stress, limiting the scope for meaningful near-term displacement.
- The gold price initially declined on news of the war. Current levels suggest that a significant geopolitical risk premium is already embedded.
- Concerns around systemic risks remain contained. Despite tighter financial conditions and geopolitical uncertainty, areas such as private credit do not currently exhibit signs of systemic stress. As noted by Howard Marks, the asset class appears structurally more resilient than in past cycles, with limited evidence of excess leverage or widespread deterioration in credit quality.
- Geopolitical fragmentation risks are being reassessed. The Middle East conflict has raised broader questions about lobal alliances and stability. While there is some evidence of a breakdown in established institutions, there is a clear trend toward increased defence spending and strategic realignment, particularly among Western economies.
Opportunity: Where Is Value Emerging?
- Market dislocations are creating more attractive valuations. The sharp repricing in regions most exposed to energy shocks, particularly in Asia, reflects heightened sensitivity to Middle East developments rather than a deterioration in underlying fundamentals. Similarly, US smaller companies remain attractively valued relative to large caps, providing potential upside as macro conditions stabilise.
- Energy and defence sectors stand to benefit structurally. The Middle East conflict is likely to reinforce already rising global defence spending and accelerate investment in energy security. This includes diversification of supply, increased domestic production, and a renewed focus on strategic reserves. These trends create a supportive backdrop for companies operating across traditional energy, renewables, and defence industries.
- Artificial intelligence remains a powerful structural driver. While geopolitical events dominate short-term narratives, the long-term impact of AI continues to build across sectors. The rate of growth may be somewhat constrained by rising energy costs. However, beyond technology, industries such as healthcare, industrials, and defence are increasingly leveraging AI to improve efficiency and decision-making. Early evidence suggests this is translating into tangible productivity gains, supporting earnings growth even in a more uncertain macro environment.
- China’s technology sector continues to offer deep value. Although not directly linked to the Middle East conflict, Chinese equities have remained under pressure due to domestic and regulatory concerns. However, valuations are now significantly below global peers, while policy support is gradually increasing. For long-term investors, this disconnect between sentiment and fundamentals presents a compelling opportunity. Morningstar are finalising their research into an appropriate China Technology ETF.
Periods such as these are rarely comfortable, but they have historically proven to be periods where the gap between price and value widens; creating opportunities for patient, long-term investors to position for recovery and growth once uncertainty subsides.