(Image: Bloomberg)

The markets responded to news that the U.S. had killed Iran’s top military leader as expected on Friday. Stocks weakened, as oil prices and gold strengthened. 

“Global oil markets will be volatile for weeks to come. There’s a reason, finally, for caution in the stock market,” according to Greg Valliere, chief U.S. policy strategist at AGF Investments, who added in a note that a resolution of tensions with Iran is “a long, long way off.”

Commonwealth Financial Network Chief Investment Officer Brad McMillan and Raymond James’ energy analysts Pavel Molchanov and Ed Mills also have weighed in on the different risks — namely retaliation from Iran — and market scenarios that could result from the conflict.

How Bad Is Market Volatility?

“The heightened risk factors we must now consider include increased domestic political dysfunction, a rising risk of military action (either by us or against us in an already troubled area), and a probable disruption of the oil markets,” McMillan said in a note to advisors and investors.

“While some short-term volatility is almost certain, the actual effects, over time, will likely not be nearly as bad as might be feared … ,” he explained. “Based on what we know about the markets now, we’re just seeing normal volatility.”

Elsewhere, the reactions have been more severe, the Commonwealth chief investment officer says, but they were not extreme.
“Oil prices, for example, jumped a bit less than they did following the attack on the Saudi oil facilities in September … . [P]rices for [gold] are up by only about 1%. So, even the stronger market reactions are not indicating panic,” he said early Friday. (Gold was up 1.8% as of 4 p.m.)

Energy Independence

McMillan sees a couple of reasons for the lack of panic. 

“First, the major potential risk — to oil markets — is mitigated by the fact that the U.S. is now the largest producer of oil and essentially approaching energy independence,” he said, noting that U.S. oil supplies are less vulnerable today than they used to be. 

“Second, in general, a war sends stock markets into positive territory after the initial period of volatility,” McMillan said. His colleague Anu Gaggar examined this phenomena during the height of the North Korea confrontation a few years back.

Additional Risks 

Despite some of Gaggar’s analysis, there are several reasons why war could be more damaging this time around, McMillan says.

“The major factor, from a market perspective, is that most companies now have global supply chains, so a war anywhere could disrupt the business environment around the world,” he explained. 

Still, most companies — with the exception of large energy firms — do not source materials and other inputs extensively from this region, McMillan adds. 

“The headlines are scary — and deservedly so. This event could lead to a major escalation of the U.S.-Iran conflict, and it will likely result in military actions from both sides. Expect more headlines,” the CIO said. 

While he expects more market volatility, and for the prices of oil and gold to “certainly bounce around …, any damage to your investments is likely to be relatively small and short term,” McMillan noted.

“The effect might even end up being positive,” he explained. “As a citizen, I am paying attention and concerned. As an investor, not so much.”

‘Rising Risk Premium’ for Oil 

For Raymond James’ energy team, the focus on analysis is on whether or not Iran’s response will actually lead to a disruption in oil supplies — which they see as part of a “raising the risk premium” in oil prices.

“The U.S. assassination of a top Iranian general marks the most serious escalation in U.S.-Iran relations since the Trump administration’s withdrawal from the nuclear agreement in May 2018,” the group said in a note Friday.

Though there is “no immediate impact” on oil supplies to the U.S., the killing of the Iranian leader and related tensions in the region have raised “the geopolitical risk premium in oil prices.”

How would Iran respond? To assess this, Raymond James’ analysts spoke with Brett McGurk, a former top U.S. diplomat, who explained that the man assassinated at the Baghdad airport, Gen. Qassem Soleimani, was “by some accounts the number-three person in the [Iranian] government.”

The U.S. government viewed Soleimani as responsible for the recent ransacking of the U.S. embassy there and as a major supporter of President Bashar Assad’s regime in Syria, the analysts say: “Iran seems certain to retaliate, though there is no way to predict precisely how.”

We’re now in “uncharted territory,” they point out. This could result in “limited tit-for-tat retaliation using proxies” or “direct Iranian military action against U.S. allies such as Saudi Arabia, or even U.S. forces in the region.”

But from an economic perspective, an Iranian blockade of the Strait of Hormuz “would be the most dramatic option — with massive read-through for the oil market (nearly one-sixth of global oil supply transits the Strait) — but this would also be a case of ‘cutting off one’s nose to spite one’s face,’ given the damage this would cause to Iran’s own economy,” the analysts said. 

The Trump administration could give Iran “an off-ramp scenario,” they add, and work to bring Iran back to the negotiating table.

“It is a safe bet that, in an election year in particular, the administration would not want an all-out war in the Middle East. Secretary of State Pompeo made comments today that point to a desire to de-escalate,” the Raymond James analysts explained. 

“On the flip side, the State Department’s brand-new travel warning for all Americans to leave Iraq is unprecedented, pointing to genuine concern about future military action,” they said.

No Immediate Impact

The most obvious difference between this week’s event and the Saudi drone attack of several months ago is that “there is no immediate, direct impact on oil supply,” the analysts add.

Beyond a blockade of the Strait of Hormuz, Iran could move to attacks on oil-industry targets in Saudi Arabia and/or other U.S.-allied Gulf states. 

“While there is no way to quantify the probability of any such event, suffice it to say that our baseline oil price forecast for 2020 — $65 [West Texas Intermediate], $70 Brent — does not assume any incremental supply disruptions,” the Raymond James team said.