The safety of civilians and our troops is the most important consideration in this conflict. History suggests that maintaining a longer-term perspective is the best way to achieve financial success when faced with significant uncertainty. A quote often attributed to Winston Churchill is "the farther back you can look, the farther forward you are likely to see." The same could be said of energy price shocks which have occurred every decade or so. While each situation is unique, there is a clear pattern of oil prices surging in response to geopolitical conflict, the resulting market volatility, and the subsequent calm and recovery.
The situation is unfolding in real time and there are no guarantees as to when there will be stability in the region or in financial markets. Events over the past few years including other Middle East conflicts, inflation, trade wars, and Venezuela earlier this year, all provide important context and perspective. What should investors keep in mind in the coming weeks?
For investors, energy prices are primarily how geopolitical events affect the broader economy and financial markets. The impact of each conflict is different, depending on how it changes supply and demand. At the moment, higher oil prices are due to the transportation of oil, storage capacity, and production cuts by major oil producers across the Middle East. The potential duration of the war is also a factor as Iran appoints a new supreme leader.
The epicenter of the current jump in oil is the Strait of Hormuz, a narrow waterway that connects the Persian Gulf to the rest of the world. Roughly 20% of global oil shipments and a significant share of natural gas pass through this chokepoint each year. While Iran cannot technically close the strait, attacks on tankers and safety concerns have been enough to halt traffic. Major shipping and logistics companies have restricted or suspended bookings through the region, and hundreds of oil tankers are at a standstill inside the strait.
It is often thought that when oil prices rise above $100, the economy starts to falter, affecting household budgets and inflation. Yet, it’s important to keep these moves in perspective. While oil prices have been quite low over the past few years, they have experienced swings throughout history. When Russia invaded Ukraine in early 2022, Brent crude surged to nearly $128 per barrel, pushing average gasoline prices in the U.S. above $5 per gallon. Before that, the mid-2000s saw oil reach record highs driven by rapid global economic growth ahead of the 2008 financial crisis. In each case, prices eventually settled as supply and demand adjusted.
How higher oil prices affect consumers and businesses
The U.S. is in a stronger position today than during previous oil crises due to the shale revolution. As the world's largest producer of both oil and natural gas, the U.S. benefits from energy independence that did not exist during other historical oil shocks. While oil is a globally-priced commodity and the U.S. still imports some types of crude, this helps to insulate the domestic economy more than others in Asia and Europe. In fact, the U.S. is seen as a “swing producer,” meaning it can ramp up production when oil prices are high.
At the moment, gasoline prices have risen back toward $3.50 per gallon across the country, and could climb further. While higher, this is still well below the $5 per gallon price experienced four years ago. Of course, there are many more indirect effects on consumer prices. Rising energy prices raise the cost of transporting goods, manufacturing products, and powering businesses. In this way, higher oil prices function as an effective tax on the economy by raising the costs of all goods and services, reducing disposable incomes.
This is what economists sometimes refer to as "cost-push inflation.” When the cost of oil rises sharply, businesses face higher production costs that are eventually passed on to consumers. This is different from demand-driven inflation, where prices rise because consumers are spending more, such as when government stimulus checks are issued. This distinction matters because supply shocks tend to be viewed by economists and investors as “transitory,” meaning the effects will eventually fade.
Markets can weather higher oil prices
Despite these historical lessons, the reality is that financial markets can react to oil price shocks in the short run. The S&P 500 is only down a couple of percentage points year-to-date, but many headlines are highlighting the South Korean KOSPI index’s decline of 17%, Japan’s Nikkei index’s 10% fall, and others since the end of February. What they don’t emphasize is that the KOSPI and Nikkei are still up over 104% and 40%, respectively, over the past year, even with these recent declines. Markets never move up in a straight line, so it’s important to maintain this broader perspective.
Of course, this doesn't mean markets won’t continue to experience daily swings. Instead, it’s a reminder that properly-constructed asset allocations and financial plans are designed precisely to handle these types of risks. Making dramatic portfolio changes in response to headlines is often counterproductive. Successful investing is more often achieved by maintaining balanced portfolios and staying focused on long-term financial plans.
While the conflict in Iran has pushed oil prices above $100 and created volatility, financial markets and the economy have historically adapted to supply shocks. Investors should maintain perspective, stay diversified, and continue to focus on their long-term financial goals rather than reacting to daily geopolitical headlines.
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