Earlier this year Energy was one of the better-performing sectors, rising 17% from January to April. Fast forward to the middle of September, and Energy had the worst one-year performance (-4.59%), hampered by weakening demand and potential increased output from OPEC+.
Wall Street sentiment can change in an instant though.
Energy stocks got a big jolt at the start of October, and the broader market fell, on fears of widening tensions in the Middle East.
How Will Middle East Tensions Drive the Stock Market?
Armed conflict has been ongoing since October 2023 between Israel and Hamas-led Palestine in the Gaza Strip. Tensions have significantly ramped up since the start of October with escalating tensions between Israel and Iran. This includes unprecedented missile attacks between Iran and Israel, which could upend the stability of oil supplies in the oil-rich Middle East.
The White House saying it supports Israel’s defense strategy and warning any direct military attack from Iran against Israel will face serious consequences, is adding fuel to the fire.
In a matter of days, Energy has gone from the worst to best-performing sector on Wall Street. As of this writing (October 3), the Energy sector has advanced by 6.5% over the last week. Big oil stocks have rallied, even as the broader markets have fallen.
The recent gains in oil prices, from $65.0 per barrel to just under $74.00 per barrel, are significant, but modest in the grand scheme of things. It’s still trading approximately 15% below the 2024 high of $87.00 per barrel set in April.
Oil prices could jump a lot higher. By all accounts, it appears as though energy traders are waiting to see what happens over the next few weeks. A direct retaliatory strike by Israel on Iranian oil assets could result in a dramatic increase in energy prices. Iran is responsible for around 4% of global oil output. Iran, meanwhile, could retaliate by attacking energy shipping in the Strait of Hormuz.
Should the conflict expand beyond Israel and Iran, production in the entire region could shut down. Severe investor panic would probably set in and result in a big spike in oil prices.
What Other Investments Do Well During Periods of Conflict?
Rising oil prices are not the only effect of escalating tensions in the Middle East. Gold prices have jumped to record levels on safe-haven demand, as fears of a full-on war in the Middle East escalate.
In addition to precious metals being a safe-haven investment, investors moved their money into gold after the benchmark U.S. 10-year bond yield slipped, making bullion, which has no yield, more appealing.
Military and defense stocks have turned more bullish. Since Hamas attacked Israel on October 7, 2023, the iShares U.S. Aerospace & Defense ETF has rallied more than 47%.
A larger, more expansive escalation could also shake the global economy. And, with stocks at record levels, a broader sell-off could be on the table. A big shock to the global economy could also impact how central banks respond to near-term interest rate cuts.
It seems even once overly optimistic investors are starting to take notice. The Cboe Volatility Index (VIX), which is referred to on Wall Street as a fear gauge, has jumped more than 35% since late September. The VIX measures volatility in the stock market for the next 30 days. When Wall Street gets anxious, the NYSE and Nasdaq fall and the VIX goes up.
Iran fired missiles on Israel, but it’s how Israel responds that will drive the stock market over the longer term. And that’s what’s making investors more fearful.
How will that impact the stock market? Some sectors and stocks are expected to perform better than others. That’s why it’s important to have a selective strategy when it comes to investing.
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