Despite the war in Iran and the uncertainties it creates around inflation and monetary policy, equity indices have so far held up well in the face of this new geopolitical crisis. An unusual and, dare we say, somewhat cynical market behavior.
Since February 28, investors’ daily lives have been shaped by news coming out of the Middle East. The duration of the conflict, access to the Strait of Hormuz, the prospect of a ceasefire, the trajectory of oil prices, and the impact on inflation, and by extension monetary policy, are all sources of uncertainty for financial markets. This article does not aim to speculate on how the situation will evolve.
Indeed, such an analysis would risk becoming obsolete even before publication, given how unpredictable and inconsistent the actors in this conflict are. Instead, what is interesting is to analyze how equity markets have behaved over the past two months and, above all, to understand why they have so far shown such resilience.
Stairs up, elevator down
According to an old Wall Street adage, markets “take the stairs up and the elevator down.” In other words, prices tend to rise gradually but fall sharply during corrections.
In the case of the war in Iran, however, the opposite has occurred: equity indices declined only modestly and in an orderly manner following the onset of U.S.-Israeli military operations, before rebounding sharply in April.
One key to this unusual and arguably cynical market behavior lies in investor confidence in continued economic growth. While markets are quick to react to inflation risks and question future rate cuts by the U.S. Federal Reserve, they seem to believe that the oil shock will have limited impact on overall economic activity.
Positive signals
Indeed, across the globe, manufacturing PMI indices leading indicators of economic activity, have improved over the past two months. The Australian dollar, often seen as a barometer of global economic health, has maintained its upward trend since last autumn. Meanwhile, credit spreads widened only marginally in March, suggesting that concerns about corporate defaults remain contained.
The relative resilience of Chinese equities also supports this growth-driven explanation. As long as global economic conditions remain intact, China has little to worry about: its goods exports, a cornerstone of its current economic model, should remain strong.
On the inflation front, China also holds certain advantages over Western economies. Not only were the few oil shipments that passed through the Strait of Hormuz largely destined for China, but the country also benefits from substantial crude reserves and a significantly lower dependence on oil and gas. This is due to massive investments in renewable energy in recent years, combined with the continued use of coal.
The Role of Technology
Another explanation for the relative resilience of equity markets lies in their composition. The weight of large technology companies in the S&P 500, roughly one-third, and even in emerging market indices, has become so significant that their trajectory largely determines overall market performance.
And it is clear that tech giants are relatively unaffected by developments in the Middle East, at least as long as energy shortages do not disrupt the construction or operation of data centers essential to AI.
It is also possible that short-covering activity has contributed to the recent rebound in technology stocks, and therefore to the broader market. The sector had suffered earlier in the year as investor concerns focused on the monetization of massive AI investments and the disruptive impact of this technological shift on software companies.
The “Trump Put”
A third, more subjective explanation lies in the attention paid by the U.S. president to stock market developments. This has been dubbed the “Trump put”: when Wall Street shows signs of excessive stress or declines too sharply, presidential rhetoric tends to become more conciliatory on social media, and/or prior policy decisions may be reversed.
In markets increasingly driven by algorithmic trading, index funds, and platforms that encourage speculation, this short-term “noise” often overrides fundamental considerations.
What Should We Take Away?
First, economic data must be closely monitored. If growth were to weaken, it could undermine the resilience of equity markets, particularly in the technology sector and in China.
Second, portfolio diversification should take precedence over attempts to time the market.
True Diversification
However, this diversification should not necessarily rely on government bonds, which combine inflation risk with more structural concerns around public debt sustainability. In our view, diversification should primarily be achieved within equity allocations, across sectors, regions and themes while also including exposure to alternative assets and gold.
Gold has indeed lost some ground in recent weeks, likely due to selling by emerging market central banks defending their currencies. However, this should not be interpreted as a loss of its safe-haven status. History shows that gold does not always appreciate during immediate periods of stress; over time, however, it remains an excellent hedge against extreme risks.