How Will the Israel-Hamas War Affect the Markets?

Which sectors are affected by the Israel-Hamas war?

During times of geopolitical uncertainty, investors turn away from riskier investments in the stock market and toward safe-haven investments, sometimes called defensive assets. These include US treasury bonds, gold, utilities and energy.

With the threat of a drawn out conflict in the Middle East, there is increased potential for oil supply disruptions, which often translate into spikes in the oil price. This could further benefit safe-haven assets.

“In a scenario where the conflict expands and draws in other regional actors, we believe safe-haven assets including US Treasuries and gold would gain further from investors' attempts to hedge against stronger escalation or a global economic slowdown driven in part by higher oil prices,” states UBS Wealth Management.

The other usual suspects in this scenario are oil and gas stocks as well as defense stocks, says CNBC International editor, Yeo Boon Ping.

Is now a good time to buy defense stocks?

Defense stocks obviously perform well when geopolitical tensions are at their highest. On October 18, CNN Business reported that the iShares U.S. Aerospace & Defense ETF (BATS:ITA) had gained about 7 percent in the 11 days following Hamas’ attack on Israel.

The fund tracks 33 companies including Raytheon (NYSE:RTX), Lockheed Martin (NYSE:LMT), Boeing (NYSE:BA), General Dynamics (NYSE:GD) and Northrop Grumman (NYSE:NOC).

However, a rally in defense stocks following geopolitical conflicts is often transitory. As CNN Business senior markets reporter Nicole Goodkind highlighted, “Following Russia’s invasion of Ukraine, the iShares defense ETF surged by 5 percent, with Lockheed Martin and Northrop Grumman’s shares jumping about 20 percent. But within six months, these stocks reverted, losing most of their gains.”

Another factor limiting gains for defense stocks at this time is that the US Congress remains without a speaker of the House at the time of this writing. Until a new house speaker can be elected, Congress can’t approve Biden’s proposed budget, which includes increased military spending, nor can any decisions be made about defense funding for either Israel or Ukraine.

How could the Israel-Hamas war affect oil prices?

Not surprisingly, oil prices climbed on the news that Israel had declared war on Hamas. While the price of crude oil remains below the highs seen in 2022, the possibility looms of much higher prices on the horizon if the war escalates throughout the region and impacts major oil producers.

For now, all eyes are on Iran. It’s common knowledge that the Iranian regime provides material support to Hamas. However, Iran has denied it directly backed Hamas’ October 7 terrorist attack on Israel. Nevertheless, both the country’s foreign minister and Supreme Leader Ayatollah Ali Khamenei have threatened that Israel’s imminent ground invasion of Gaza would draw in Iran-backed armed groups in the region, including Hezbollah, who threatens Israel on its northern border with Lebanon. On October 18, Iran called on Middle Eastern oil producers to enact an oil embargo against Israel; however, OPEC doesn’t seem interested in making such a move.

“The big question mark surrounds a possible spillover of the confrontation, which could affect major oil producers in the region, and how such a scenario could affect the global supply of crude,” Ricardo Evangelista, the senior analyst at ActivTrades, told the Guardian. “Against this background, uncertainty will remain high, in a dynamic likely to continue to support the price of the barrel.”

If Iran steps into the fray, investors should look out for the US to impose even tougher sanctions on the Persian nation’s crude oil exports, said analysts at UBS Group (NYSE:UBS). The firm expected oil prices to reach US$95 per barrel by the end of 2023, stating “in an already undersupplied market, disruptions to Iranian exports either through a broadening of the conflict or tougher sanctions could have a significant impact on oil prices in the near term.”

On the flip side, if the war remains isolated to Israel and Hamas, the impact on energy markets will remain subdued. LPL Research portfolio strategist George Smith points out that Israel’s contribution to global GDP is a mere 0.5 percent, and the nation is not a major oil producer.

Another factor to consider is that oil’s dominance in the energy sector has been muted in recent years by the rise of alternative energy sources, notes NASDAQ contributor Martin Tillier. He also emphasizes the impact of hydraulic fracturing in the US on the market dominance of Middle Eastern oil production.

For its part, Trading Economics has said the growing possibility of the US lifting sanctions on Venezuelan oil exports will help to stabilize prices. The firm is forecasting crude oil prices of US$97.95 per barrel in 12 months time.

These factors and others greatly diminish the potential impact on the oil market to far less that what was experienced during the 1970s oil crisis brought about by the Yom Kippur War of 1973 and the Iranian Revolution of 1979.

What could happen to the price of gold during the Israel-Hamas war?

True to its safe-haven nature in times of uncertainty, the gold price has seen a boost following the outbreak of the Israel-Hamas war. But as many analysts have indicated, the impact of geopolitical tensions on prices for the precious metal are often short-lived.

"Geopolitical rallies in gold tend not to last long,” said Adrian Day, president of Adrian Day Asset Management. “In the longer term, monetary factors are more important for the gold price."

Brien Lundin, editor of Gold Newsletter, agrees with Day’s sentiment. In an interview with INN, Lundin said that geopolitical eruptions are typically not a fundamental driver of gold prices. “The real reason to buy gold is when you think that your currency is going to lose its purchasing power at an accelerating pace in the near future,” he added. “That’s the primary driver that creates long-standing and powerful, consistent bull markets in gold, and that doesn’t happen from a geopolitical flare up.”

How will the Israel-Hamas war affect inflation?

While it's possible we’ll see a return to lower interest rates sooner than later, voices in the financial markets are sounding the alarm about the potential for the Israel-Hamas war to escalate global inflation in the longer-term.

JPMorgan’s (NYSE:JPM) Jamie Dimon has warned that the conflict may further curtail already restrained global trade, and lead to higher energy and food prices. “This may be the most dangerous time the world has seen in decades,” Dimon stated in a press release alongside his bank’s third quarter earnings report.

The potential impact of the war on global markets would be another nail in the coffin for the era of globalization, says Wells Fargo (NYSE:WFC) international economist Brendan McKenna, which could lead to rising inflation and higher interest rates.

“Global markets have yet to fully price the inflation risks from developments — from higher oil prices and more defense spending,” warned Bob Savage, head of markets strategy and insights at BNY Mellon (NYSE:BK).

Historically, defense spending is considered inflationary by economists. “All wars are generally associated with some inflation. Politicians don’t like to put up taxes (to pay for wars), and inflation is a hidden tax,” explained Richard Sylla, co-author of "A History of Interest Rates," at the time speaking about the Russia-Ukraine war.

With these two ongoing wars, the US and potentially other concerned nations may be taking on more debt to prop up their military spending and aid to both regions.

How should investors position their portfolio during the Israel-Hamas war?

As during any time of rising geopolitical tensions and slowing global economic growth, UBS recommends “that investors should strengthen the core of portfolios, with a diversified multi-asset approach.” The firm says investors should look to “fixed income compared to equities” and “high-quality bonds in the 5–10-year maturity range.”

Sticking to your long-term investment goals is also important. That’s why Motley Fool Asset Management is not changing up their portfolio in consideration of the Israel-Hamas war, according to the firm’s chief investment officer Bryan Hinmon.

This approach might well be the best choice given the historical record for how markets react to and recover from intense geopolitical conflicts. “The impact in the longer run from geopolitical events tends to be somewhat contained,” Meera Pandit, global market strategist at JPMorgan Asset Management, told CNBC.

To better understand the future, look to the past. The chart below from LPL Research provides excellent reference points.