Geopolitical fades are usually short-lived, says Morgan Stanley

by Michael Msika

US strikes on Iran’s nuclear facilities are dominating headlines but selloffs caused by geopolitical events tend to be brief, according to Morgan Stanley strategists. 

Market reaction has been muted after the US joined Israeli attacks over the weekend, with Brent crude prices rising as much as 5.7% before paring most gains on Monday. Still, Iran could respond to the escalation by disrupting traffic through the Strait of Hormuz, a major route for oil and natural gas. 

“History suggests most geopolitically-led selloffs are short-lived/modest,” strategists led by Michael Wilson wrote in a note on Monday. “Oil prices will determine whether volatility persists.”

According to the Morgan Stanley team, prior geopolitical risk events have led to some volatility for equities in the short term, but one, three and 12 months after the events, the S&P 500 has been up 2%, 3%, and 9%, on average, respectively. 

Equity investors had prepared for the possibility of US intervention in Iran by trimming their exposure, while demand for hedging increased in the days before the airstrikes. Yet stocks had declined only moderately and most of the recent volatility was concentrated in oil markets, with Brent up over 20% this month to trade around $77 per barrel. 

Meanwhile, a couple of tailwinds — the weaker dollar and a pickup in earnings growth, are supporting US stock prices, Wilson said.

Equity investors could become nervous if oil prices continue to rise. The effect on inflation and the economy would likely be significant and threaten the path lower for interest rates. 

“If the Strait of Hormuz is shut, we expect a major stagflationary shock similar to 2022,” wrote Panmure Liberum strategists Joachim Klement and Susana Cruz. “In this case a 10% to 20% correction seems likely, and we could see a new bear market if the trade war escalates again in early July.” 

For Wilson and his team, an oil price surge would have to be significant to create a bear case scenario. Based on their analysis, oil would need to hit $120 per barrel before posing a threat to the business cycle.

“While we’re respectful of the risks, there’s a long way to go on this basis,” wrote Wilson.

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