US Steps into Israel/Iran conflict
On 22 June (NZT), Trump announced that the US had bombed three nuclear facilities in Iran – Fordow, Natanz and Isfahan. Following the attack, Trump warned of further action should Iran not agree to a diplomatic solution over its nuclear programme. The world now awaits the Iranian response.
Risk of wider escalation in region have intensified
The US’s involvement in the Israel/Iran conflict has raised the likelihood of a wider escalation in the region. Prior to the attack, Iran had suggested that they would retaliate against US bases in the region if the US was to get involved in the conflict. In the hours since the US bombed Iran, Tehran has retaliated – so far only against Israel. Iran will certainly be considering ‘non-linear’ options for retaliation.
From a market’s perspective, the heightened geopolitical uncertainty is expected to weigh on sentiment in the near-term as investors price in the risks of further escalation in the region including a disruption to the supply of oil and the ramifications this could have on inflation, interest rates and global growth.
While Iran’s contribution to the global supply of crude oil is relatively low at around 5%, the wider Middle East region including Saudi Arabia, UAE and Kuwait produce around 30% of the world’s supply, most of which is shipped through the Straits of Hormuz.
Narrow waterway a critical energy chokepoint
With roughly 20% of global oil passing through the Strait of Hormuz (mostly destined for Asia), it is arguably the world’s most critical energy chokepoint.
During various conflicts over the past several decades, Iran has repeatedly threatened to close the Straits (by attacking ships or laying mines), however, they have never acted on these threats given the country’s heavily dependency on the Strait for its own oil exports and the swift international response it would likely trigger.
In 2020, we saw an example of a more ‘symbolic’ retaliation by Iran after a US drone strike near Baghdad airport killed Iranian General Qassem Soleimani. This prompted Iran to retaliate by launching over a dozen ballistic missiles at US bases in Iraq on 8 January – causing injuries but no immediate fatalities. The brief escalation led to a temporary spike in oil prices and a very short-lived decline in global markets, as investors initially feared a broader conflict. However, markets quickly rebounded within days after both the US and Iran signalled a desire to de-escalate, easing concerns of a prolonged military confrontation.
However, if Iran were to follow through with more substantial retaliation such as closing the Strait or attacking energy facilities in the region, oil prices could spike sharply, with some economists raising the possibility of oil reaching $120–130 per barrel.
What is important to remember is that the movement we have seen in the oil price since the low point in April (+26%) has been due to a re-pricing of risk, not any actual disruption to supply. Both Israel’s and the US’s attacks on Iran have primarily been focused on Iran’s nuclear sites, not its oil infrastructure and there has been no decline in oil exports from the region.
Unless supply is meaningfully disrupted – either via the Strait of Hormuz or an escalation and broaden of the current conflict – oil prices are likely to remain volatile but contained.
The global economy is less reliant on oil than it once was
While the risks to global oil supply have risen, the broader economic consequences from higher oil prices would likely be milder than in the past. This reflects the fact that the global economies reliance on oil, as measured by oil intensity, has decreased considerably over the past two decades.
Oil intensity measures the volume of oil consumed per unit of gross domestic product and is often viewed as one of the best overall measures of how efficiently we use oil.
It is influenced by several factors: changes in consumer choices (like switching to electric cars), improvements in technology (such as fuel-efficient engines), and shifts in the economy (like moving from manufacturing to services, or more people living in cities and using public transport). Together, these changes reduce how central oil is to economic growth.
These changes have primarily been driven by improvements in energy efficiency – especially in transportation – and a shift toward alternative energy sources. Government regulations mandating fuel efficiency, the replacement of oil in power generation, and the rise of renewable energy have all contributed.
Governments have also invested in strategic petroleum reserves and policies that reduce oil dependence.
These structural changes mean that elevated oil prices, while still inflationary, would likely have a smaller impact on global growth than in past cycles. The US in particular is less vulnerable thanks to its shale oil, which can even turn higher prices into a growth driver through increased investment.
How has a balanced portfolio performed during previous shocks
In uncertainty situations like this, it is always helpful to take a step back and remember why you are investing in the first place. For many of us, it is for our future and to ensure that the spending power of our investments keep ahead of inflation. As long-term investors, we will see many market shocks over our lifetimes, with the conflict in Iran a further example of this.
In fact, over the past 25 years there have been several instances of conflict related market shocks and each time the global economy and equity markets have recovered – that’s a 100% recovery rate.
In the graph below, we show the performance of a 60% stock/40% bond portfolio over the one- and three-year periods following previous conflicts. With the exception of the September 11 attacks in the US in 2001 and Russia’s invasion of Ukraine in 2022, markets have generally pushed higher following the initial pullbacks that accompany periods of heightened uncertainty in markets.
It is a similar situation when we look more closely at the performance of the US and New Zealand equity market.
Remember not to panic
As we, and the world, watch to see whether the US’s involvement will escalate tensions or bring about a quick resolution to the conflict, below are some thoughts on how to navigate these uncertain times.
Even if oil prices do rise, the broader economic consequences today would likely be milder than in past decades. That’s because the global economy has become more energy efficient.
Central banks still have enough firepower to cut rates if oil prices remain elevated for an extended period and growth slows. Such rate cuts could boost fixed income returns, helping to offset potential declines in growth assets.
A well-diversified portfolio is essential to protect against the risk of an escalation in the Middle East, higher oil prices and the re-emergence of inflation.
Focus on fundamentals, don’t overreact to every news headline and remember not to panic. It is your behaviour during these challenge periods that determines your long-term returns.
A reminder to rebalance. Check that your exposure to the different asset classes hasn’t drifted too far away from your target asset allocation, exposing yourself to more risk than you originally intended. Weakness of quality growth assets in stress is often an opportunity in the rebound.
The recent oil price increase reflects a rising geopolitical risk premium rather than actual supply loss. Unless there is a serious supply disruption – especially involving the Strait of Hormuz – the economic and market impact is likely to remain contained.
Gold often performs well in the early stages of geopolitical shocks, though gains are rarely sustained without deeper conflict escalation. For investors concerned about further escalation in the Middle East, a small (max 2%) allocation to gold in portfolios could be considered.
Energy opportunity. While energy prices may move higher from current levels and energy stocks outperform, energy spikes are more of an inflation indicator than a thematic that will lead to long-term growth. For investor seeking an exposure to the energy thematic, we would recommend gaining this through a diversified exposure such as iShares Global Energy ETF. In this scenario, ESG focussed portfolios, which typically exclude energy, are likely to experience a performance lag.
Markets are upward trending over the long-term. However, over shorter time periods, markets can be very volatile and means we are all likely to experience losses in our portfolios at some point during on investment journey. That’s the trade-off for generating higher returns.
While market volatility can feel uncomfortable, if there's one thing I’ve learned from 25 years of investing – through the TMT bubble, geopolitical conflicts, the global financial crisis, and a once-in-a-century pandemic – it’s that these periods often present meaningful opportunities. One of the worst mistakes investors can make during market downturns is to panic and sell.
In today’s uncertain environment, the Craigs Investment Committee maintains a small tactical tilt towards income assets (bonds) over growth assets. Both domestic and global bonds are offering attractive yields (4.5%+), making them a compelling option for income-focused investors. We expect them to continue acting as a ballast in portfolios as we navigate ongoing uncertainty.
We will continue to watch developments closely and keep you updated on what they mean for markets and your portfolio. If you would like to discuss your portfolio in particular, please contact your adviser.
Private Wealth Research 23/06/2025 (Circulated with permission from Craigs)
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