Even though Sunni extremist fighters advanced deeper into Iraq over the weekend and President Barack Obama demonstrated reluctance to offer support to the Iraqi military, financial markets are treating the latest episode of global unrest as if it is another day in the Middle East.
“We all know that bad things will continue to happen in the Middle East and for that reason the markets have already factored in the geopolitical risk from the Middle East,” said Doug Coté, chief investment strategist at Voya Financial Inc.
Photos posted on social media sites claim to show mass executions of captured Iraqi soldiers and Iran is reportedly stepping in to offer Iraq some military support. But markets opened the week essentially unfazed by what looks like an entire country being taken over by Islamic extremists.
Meanwhile, the S&P 500, which opened Monday in negative territory, had eked out a gain of less than 1% by 1 p.m. Eastern Time. The 10-year U.S. Treasury bond was down 0.08%, crude oil was up 0.34%, and gold prices were up 0.11%.
“These same geopolitical events against a different economic backdrop would produce different outcomes,” said Rob Stein, chief executive of Astor Investment Management.
“Right now the U.S. economy is solid, even if it isn't accelerating the way it could be,” he added. “But a few years ago, this same news out of the Middle East would have a much larger impact on the markets.”
Mr. Stein acknowledged that the escalating conflict in Iraq will make for a “bumpier ride” across the financial markets this summer, “but the direct impact on stocks is probably just your typical speed bump of the kind of unknowing events you wake up to any morning.”
Quincy Krosby, a market strategist at Prudential Financial Inc., said a major tipping point for the financial markets could be sparked if the price of oil starts to spike.
“If there's an expectation of an interruption of the oil supply, a risk premium will be put into the price of oil and right now, that's what the market is watching,” she said. “The market already pulled back on the initial escalation of the tensions in Iraq, and right now the market is looking at whether it needs to take a long-term or a short-term view of what's going on over there.”
If energy prices represent the tipping point for financial markets, Todd Rosenbluth, director of mutual fund and exchange-traded fund research at S&P Capital IQ, said a few funds will likely ride the wave of higher prices.
If oil prices start to rise, he said you can't go wrong with exposure to petrochemical giants Chevron Corp. (CVX) and Exxon Mobil Corp. (XOM).
“Most diversified energy ETFs will have lots of exposure to Chevron and Exxon,” he said. “They are the 800-pound gorillas of energy stocks.”
The two dominant energy ETFs are the $11.4 billion Energy Select SPDR (XLE), and the $3.7 billion Vanguard Energy (VDE).
On the exploration and product side of the energy market, Mr. Rosenbluth pointed to the $1.2 billion SPDR S&P Oil & Gas Explore & Production ETF (XOP). For more specific oil and equipment services exposure, he recommended the $590 million iShares U.S. Oil Equipment & Services ETF (IEZ).
While the latest uprising in Iraq is tragic, it is not that much different from what has already unfolded in Ukraine or Syria, according to Zachary Karabell, head of global strategy at Envestnet Inc.
“If you took out the degree to which the U.S. was engaged in Iraq it wouldn't be much different than what's going on in Crimea or Syria,” he said, suggesting that the financial markets have already figured out that Iraq is now an arm's-length issue for the United States.
“There's a potential short trade if you believe the markets won't normalize in a couple of weeks, but other than that, the investing implications are highly uncertain,” Mr. Karabell added. “Even in oil terms, you have to believe that anyone in power in an oil-producing country wants to do anything to sell that oil.”
For additional perspective, Mr. Karabell noted that, “We're not going to live in a world absent of geo-political risk.”
“If you were walking around five days ago thinking everything was fine, you were wrong,” he said. “And if you're walking around now thinking everything is bad, you're also wrong.”