Markets retreat as oil spikes higher

Shares and bonds fell at the start of the new trading week in response to a historic spike in the oil price that threatens resurgent inflation and slowing economic growth around the world.

The cost of a barrel of crude hit $119, its highest level since the Russian invasion of Ukraine in 2022. Even after settling at around $107 a barrel, oil is up 16% on the day and has risen around 50% since the US and Israel attacked Iran just over a week ago.

The surge in the oil price reflects growing concern about oil supplies through the Strait of Hormuz, an energy choke point that has become the focus of investor attention in recent days.

Around 20% of the global supply of both oil and liquefied natural gas passes through the narrow passage between Iran and Oman every day. Since hostilities flared in the region at the start of March, traffic through the strait has more of less completely dried up as shippers and insurers have balked at risking the dangerous passage in and out of the Gulf.

The announcement that Iran’s former supreme leader, Ayatollah Ali Khamenei, will be replaced by his second son, Mojtaba Khamenei, confirms investors worst fears that Iran intends to strongly resist US and Israeli attempts to overthrow the Islamic regime in Tehran.

The longer the conflict goes on, the greater will be the expected hit to the global economy and to financial markets.

• Get updates on markets, ISA funds, pension saving and much more

Market reaction

Shares in Asia’s big energy importers were the first to reflect the fast-changing economic dynamic, which has worrying echoes of the 1970s oil crises that fuelled a stagflationary spiral of rising prices and slowing growth.

South Korea’s Kospi index fell 6%, Japan’s Topix was 4% lower, as was Taiwan’s Taiex index. The sharp falls also reflect the strong gains registered by these markets in the weeks leading up to the recent conflict.

In Europe, too, markets opened sharply lower, with shares in France and Germany more than 2.5% down and the FTSE 100 nearly 2% lower in early trading.

Bond yields pushed higher as investors demanded greater compensation for the inflation risk to future fixed income streams. The UK’s 10-year government bond now yields more than 4.7%, up half a percentage point since the start of hostilities, posing a threat to mortgage rates and raising the cost of borrowing for the government and businesses.

In currency markets, there was a modest flight to the perceived safety of the US dollar. The pound fell by just over half a percent to $1.33. The euro fell by a similar amount to $1.15. It is the lowest level for the single currency since November.
Gold, a traditional safe haven, was broadly unchanged at around $5,100 an ounce, reflecting its already strong performance in recent months.

• See our current offers to help your money go further

Lessons from history

Markets are pricing in a less benign outcome than they hoped for a week ago, even if, for now, the expectation remains that the conflict could be relatively short-lived - similar to the Gulf War in 1990.

But a less optimistic view - with echoes of the stagflation of the 1970s, also fuelled by Middle East conflict and regime change in Iran - is beginning to take hold.

Looking back at oil price spikes over the years, they have always been associated with falling equity market valuations. The most significant of these was the double hit of the Yom Kippur war of 1973 and the subsequent second oil shock of 1979 when the Shah was ousted and the current Islamic regime in Iran was ushered in. Then the US stock market earnings multiple fell from over 20 to under 10 in the most difficult decade for investors in the post-war period.

The 1990 Gulf War, after Iraq invaded Kuwait, saw a short-lived spike in the oil price and a relatively contained derating of equity markets. Then in 2008, the financial crisis was accompanied by another oil price spike, focused on the concept of Peak Oil. Then, however, the collapse in equity valuations was driven by other factors than simply the rise in commodity prices.

Most recently, the invasion of Ukraine in 2022, saw the oil price spike higher. But the reset in equity markets then was more a reflection of higher gas prices and rising interest rates than the surge in oil.

Historical analogies are complicated by the much lower sensitivity to commodity prices of the global economy today than in the 1970s as we have shifted from a manufacturing-focused to a knowledge-based economy.

Recent context

It is worth noting that even the hardest hit global markets have only given back some of the strong gains they have enjoyed over the past year. The FTSE 100 remains above the 10,000 level that it first reached only in January. The Nikkei index in Japan, meanwhile, almost doubled from its low point last April in the wake of the Liberation Day tariffs to the recent high. It too remains in positive territory for the year as a whole.

Got a burning question you want to ask? Why not drop us a line. Click here to ask your question.

• Read: The ‘sleep at night’ investment funds
• Read: Iran conflict: markets and money questions answered
• Read: 4 charts every investor needs when markets fall

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of  Fidelity’s advisers or an authorised financial adviser of your choice.