Iran war is giving markets a Covid-like shock

Shuli Ren, Bloomberg

As the Iran war drives oil prices towards $120 a barrel, a reckoning is finally coming for a reckless president and equally complacent financial markets.

Last week, reactions were muted, with the S&P 500 Index down only 2%. Even in South Korea, the world’s most frothy bourse, bargain hunters returned on Friday after the Kospi Index’s biggest one-day slump on record.

This nonchalance is normal. Financial markets often react to major events with a delay. When Covid-19 first emerged, traders initially brushed away the prospect of a global pandemic, only to move into full panic mode a few weeks later. In less than a month, the S&P 500 was sold down by as much as one-third.

As the Iranian crisis enters a second week, markets can no longer only price in a short-lived conflict. Tehran has named Mojtaba Khamenei — a son of the country’s slain supreme leader — as his successor.

On Monday, the MSCI AC Asia Pacific Index at one point tumbled the most since last April, with Korea and Japan leading the declines. Treasuries sold off as well as traders expect more bad news for the rest of the week.

As such, it’s time to anticipate the arrival of a black swan. Let’s consider what was most trendy before the US and Israel decided to launch a war against Iran on Feb. 28, because these are the corners of the market where the steepest selloffs will likely be seen.

Massive AI-related capital spending was a major theme. Four of the biggest US tech firms alone were forecast to spend $650 billion this year, an 81% jump from 2025, with billions more coming from the likes of Oracle Corp., Tesla Inc. and large Chinese players.

Meanwhile, Korea and Taiwan markets, dominated by Samsung Electronics Co., SK Hynix Inc. and Taiwan Semiconductor Manufacturing Co., became investor darlings. This narrative is now being unwound.

Imagine what might happen if oil stays above $100 for longer: Fearing renewed inflation, global central banks will no longer cut rates — and may even start hiking cycles. Credit spreads could also widen. As it currently stands, investment-grade tech companies’ credit spreads are nowhere near the peak seen in early 2020.

With their borrowing costs soaring, Big Tech might step back, cut capital spending and pop the AI-fueled equities boom. This is a reasonable conjecture, given that a record number of investors were already telling companies that they were spending too much.

And how about the workings of the financial system, which broke down in March 2020? A 25% jump in crude oil in one day, as well as 10% slumps in crowded trades such as semiconductor stocks, can make nervous investors even more frantic and prompt indiscriminate selling. It’s discomforting to see that gold, a popular debasement trade, has been falling lately, despite its historical role as a safe haven during tumultuous times. Were some sellers desperate to raise cash?

So far, President Donald Trump has brushed away the oil price spike, calling it “a very small price to pay” for destroying Iran’s nuclear threat. But is it possible that he has lost control of this war as he did with the poor pandemic response during his first term? With oil staying solidly above $100, financial markets will pay a hefty price.

[Abridged]

Courtesy Bloomberg/Shuli Ren