Why Is the Stock Market Falling Today? Crude Oil & the US-Iran Conflict, Explained

In case you have had a look at your portfolio recently and shuddered in horror, don’t blame yourself; it’s reality. Stock markets have seen some volatile ride for the last few sessions, and the reason for most of the red numbers on the screen is the one that we have all been reading about for quite some time already – the growing military tension between the USA and Iran, which always results in another crude oil shock.

The Big Picture

The beginning of September came with a downswing on the stock market. The Dow Jones Industrial Average, S&P 500, and Nasdaq Composite all were on the decline in the first trading session of the month as a result of the increased hostility between the USA and Iran in the Strait of Hormuz. The Dow fell by more than 400 points, Nasdaq declined by almost 1% amid declines in artificial intelligence companies, while S&P 500 went down by nearly 0.7%. It’s interesting to know that September is traditionally considered the weakest month for the US stock markets, and this September proves that tradition to be true.

Stocks made a partial rebound in the very next session; the Dow gained almost 300 points, while the S&P and Nasdaq indices climbed roughly 0.5%, as treasury yields managed to take a temporary break in their continuous rise. However, there is no doubt – the current situation in the stock market is far from stability and resembles a violent movement depending on news coming from the Persian Gulf.

The Situation in the Middle East

The initial cause of the current stock volatility is an increase in tension between the United States and Iran, which has been going on for several months. Two large oil tankers – one belonging to Saudi Arabia, another one owned by a South Korean ship-owner – have been attacked with unknown projectiles when trying to leave the Strait of Hormuz. The identity of those who carried out the attack is unknown, but its timing after a sequence of mutual strikes makes the traders believe in future escalation rather than de-escalation.

Strait of Hormuz plays an important role in the situation due to its status as one of the major choke points in international oil trade – a place where a significant part of the world’s oil

In response, the US has launched new air raids on facilities associated with the Revolutionary Guards of Iran in areas around Bandar Abbas and Chabahar. These actions by the US administration have been explained as a response to the efforts of Iran to lay mines in the strait and to strike at oil tankers passing through it. At the same time, the US government has promised to offer insurance coverage and naval escort to oil tankers in the strait. This exceptional measure shows how seriously the US views the problem of the shipping lane security. In the diplomatic area, one does not observe any progress in the matter: Iranian representatives demonstrate their uncertainty regarding returning to the talks, while the president of the United States openly warns the citizens about high gasoline prices in the future.

Crude Oil: The Transmission Channel

Of all the links between the war and your 401(k), oil is the one that’s closest to home. When things start heating up around the Strait of Hormuz, crude oil prices move immediately because of the risk of reduced production, rather than reduced production itself.

In the last few trading days, Brent crude oil, which is the international benchmark, has risen toward the $94 level, an increase of several percent in just a few days, while U.S.-based WTI crude oil has been rising towards $90 per barrel. This is a notable move from the level around $82-$85 just a few weeks ago. Whenever there is news about any attack or accident involving a tanker or ship, prices for the two benchmarks move higher almost instantaneously.

Higher oil prices impose a tax on other sectors of the economy. They increase production costs for airlines, shipping companies, and manufacturing firms; reduce discretionary spending by consumers due to higher gasoline prices; and importantly, may re-ignite the inflation battle that the Federal Reserve Bank thought was already won. This is why equity markets are acting so volatile these days.

The Bond Market Adds Fuel to the Stock Fire

But that’s not all there is to the story of “war is bad, oil is good, and stock market sells off.” The 10-year treasury yield in the United States has gone through the roof to levels not seen in about two years, briefly reaching levels unseen in decades along with the yields on British, German, and French sovereign debt. Oil prices go up and inflation expectations rise, and inflation expectations mean bond yields must also rise. Bond yields tend to compete against stock prices and lead to an increased discount rate applied to future profits, especially high-tech stocks where profits are projected in the distant future.

That is the reason why you have been witnessing the Nasdaq declining more than the Dow during tough times: growth stocks are affected by interest rate changes more than industrial or energy value stocks.

Losers and Winners Beneath the Surface

But not all corners of the marketplace suffer equally from the strain. Indeed, energy stocks have done exceptionally well as the sector advances year to date on higher oil prices, with companies such as Exxon Mobil and Marathon Petroleum doing quite well, even with Marathon trading at its best price since 2011. On the other hand, the travel and leisure sector, which includes Wynn Resorts, Las Vegas Sands, Carnival, and others of the same ilk, has been trading at 52-week lows based on concerns about the impact on discretionary travel costs.

The Difficult Stance of the Fed

Moreover, the employment numbers in the past weeks indicated that there was some weakness, where payroll hiring in the private sector remained the lowest since January on the latest ADP report, while inflation threats were rising due to oil. It is the classic stagflation fear: the situation where the central bank faces the challenge of weakening growth amid rising inflation expectations, without the possibility of choosing a simple policy instrument to cope with the situation. The Fed has issued somewhat reassuring comments, saying that higher yields partially represent fundamental improvement and expecting continued decline of inflation in time. However, investors remain skeptical about those comments, since energy costs have a direct influence on inflation rates.

What To Look For

There are a couple of key points to be taken into account:

Signals of diplomats

The return of talks between Washington and Tehran would likely produce a stock market rally and oil retreat.

Shipping data through the Strait of Hormuz

The continued disruption of oil tanker traffic will keep upward pressure on the cost of crude regardless of diplomatic situation.

Incoming economic data

Incoming economic data, such as the non-farm payrolls figure, which may relieve or increase worries about

What the Fed will do next

What the Fed will do next – since the probability of a Fed rate hike is already priced into the futures market – is going to depend on the way the Fed speaks, which in turn will affect both equities and bonds.

Bottom Line

The market gyrations that have taken place over the last several weeks are not due to an earnings report of a specific company nor to any specific economic number; rather, they are due to geopolitical risk directly affecting the energy market and the energy market directly feeding into the expectation of inflation and rates. Until there is some sort of clarity regarding the U.S. vs. Iran showdown, expect stocks to continue to be guided by news coming out of the Strait of Hormuz.

Disclaimer: The information provided is for general purposes only and does not constitute professional advice. The author and publisher do not guarantee the accuracy or completeness of the content. Business decisions should be made after thorough research and consultation with professionals. The mention of specific companies or products does not imply endorsement. Financial estimates are based on available data and may change. The author and publisher are not liable for any actions taken based on the content. Readers are advised to independently verify information before making business or financial decisions.

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