Events are moving fast in the Middle East and it’s no surprise that clients are keen to understand what the escalating conflict could mean for stock markets.
The commentary below comes from Nathan Sweeney, Chief Investment Officer of Multi-Asset portfolios at Marlborough International.
While geopolitical events can understandably create uncertainty, it’s helpful to step back and understand how markets typically assess these situations. When they occur, investors tend to react quickly. That initial move is often a stock market pullback, while investors assess the potential economic consequences.
But it’s important to distinguish between a pullback and a bear market. A bear market is typically defined as a decline of 20% or more in equity markets. Historically, bear markets tend to occur when the economy enters a recession.
This means that when markets initially sell off on geopolitical headlines, investors are usually asking one simple question: could this event trigger a recession?
What causes recessions?
While recessions can have many contributing factors, they are typically triggered by one of three shocks:
- Financial shock – disruption to bond markets or banking systems
- Policy shock – aggressive interest rate rises that slow economic activity
- Energy shock – a sustained surge in oil prices that squeezes consumers and businesses
As conflict has intensified in the Middle East and oil tankers have been prevented from sailing, the oil price has risen sharply. In our update last Monday, we highlighted $100 per barrel as a key threshold. After the oil price surged past that level, it was announced G7 finance ministers would meet to discuss potentially releasing supplies from their strategic reserves, which helped to ease the price rises.
The oil price that could trigger a recession
In today’s chart we’re looking again at the economic impact of the oil price. Economists often use a simple rule of thumb – every $10 increase in oil prices tends to add around 0.3% to inflation and subtract around 0.3% from US economic growth. Using a baseline of US economic growth (as measured by gross domestic product or GDP) of around 2.2% in 2025, provides a useful starting point for our analysis.
Our chart shows that even with the oil price around $100, growth would still remain positive. However, if oil were to move up to around $130 per barrel and remain at that level for an extended period, the drag on growth could become large enough to push the world’s largest economy towards recession territory. This is why markets pay such close attention to sustained oil price shocks. It’s worth emphasising though that the oil price currently remains below the $130 level.
It’s also worth underlining that our chart is designed to illustrate in very broad terms how the oil price can affect economic growth, rather than being an attempt to pinpoint the exact level that would trigger a recession. The reality is the global economy has historically proven to be more resilient to oil shocks than simple models might suggest.
The G7 talks about releasing supplies from their strategic reserves underline that governments have tools available to help stabilise energy markets. In addition, central banks can support economies by lowering interest rates if higher energy prices begin to slow growth.
An important point to emphasise is that geopolitical tensions can de-escalate just as quickly as they escalate, and historically, oil prices have often fallen just as quickly as they rose once tensions begin to ease.
Key takeaway
For investors, it’s worth remembering that while stock markets often react quickly to headlines, the global economy usually takes a much bigger shock to truly change course. Oil prices are still some way off recession-triggering levels and the economic backdrop remains resilient.
This means what’s happening in markets currently looks more like a typical geopolitical pullback, rather than the start of a bear market.
We appreciate though that market volatility can be unsettling. So, to put current events in context, we’ve provided a set of charts that show pullbacks happen from time to time and are far from unusual. The important thing is to maintain a long-term perspective to navigate these periods.
Weekly market moves and economic news courtesy of Quilter Cheviot
The MSCI All Country World Index (MSCI ACWI) ended the week off 3.7%, bringing the year-to-date (YTD) gain down to 0.5%.
United States:
With the conflict in the Middle East escalating over the course of the week and risks to global growth and inflation rising in tandem, stock markets were always going to be on the back foot. Although the main US stock market ended the week 2% lower (-1.3% YTD), it fared notably better than European peers. Value stocks, previously the year’s pace setters, were left nursing a weekly loss of 3.4% (+3.6% YTD), while growth closed off 0.7% (-5.5% YTD). Small caps bore the brunt, closing down 4.0% (+2.0% YTD).
A paring back of interest rate cut expectations in response to a potential inflationary shock saw the yield on the 10-year Treasury note move 20 basis points higher to 4.14%, (down three basis points YTD), while the 2-year Treasury yield rose 18 basis points to 3.56% (up nine basis points YTD).
United Kingdom:
Love or loathe her, spare a thought for UK Chancellor Rachel Reeves who gave her Spring Statement last week. “Inflation is down. Borrowing is down. Living standards are up…and the economy is growing”, so said the chancellor at the despatch box, just as oil and gas prices were ticking higher and as the odds of a Bank of England interest rate cut were lengthening.
Against the uncertain backdrop, London’s markets lost ground. In the stock market, large caps finished 5.7% lower (+4.0% YTD), while mid-caps were off 5.2% (+0.5% YTD). Bond markets were not immune with gilts yields moving higher to adjust to the higher inflationary / interest rate outlook. The yield on the 10-year gilt jumped 40 basis points to 4.63% (up 15 basis points YTD). Sterling ticked lower against the US dollar, closing at US$1.34 compared to US$1.35 previously.
Europe ex UK:
The MSCI Europe ex-UK Index switched into risk-off mode too, ending the week 5.8% lower (+0.3% YTD). At the national level, Germany’s main stock market shed 6.7% (-3.7% YTD); France’s -6.8% (-1.9% YTD); Italy’s -6.5% (-1.5% YTD); and Switzerland’s -6.6% (-1.3% YTD). An increased chance of an interest rate hike from the European Central Bank to tackle the inflationary forces unleashed by the conflict saw the yield on the 10-year German Bund move 22 basis points higher to 2.86% (flat YTD). And as with sterling, the euro weakened against the US dollar to US$1.16 from US$1.18.
https://www.quiltercheviot.com/news-and-events/articles/weekly-comment-markets-move-to-the-beat-of-the-oil-drum/?memberurlid=2T85636737294P7363