Market Extra: Are stock-market investors complacent about Iran?

Investors were arguably complacent about U.S.-China trade tensions, only to be caught off-guard last week. Some analysts wonder if they’re making the same mistake when it comes to Iran.

Indeed, headlines surrounding U.S.-China relations — and trade, broadly — appear to be driving stocks up or down depending upon their tone, largely to the exclusion of other news. Meanwhile, growing turmoil in the Middle East, while garnering at least the passing attention of oil traders, seems to be going largely unnoticed by equity investors.

“The risks of a Middle East military confrontation are rising sharply amid twin attacks on energy assets in the Gulf and the U.S. decision to order an evacuation of nonessential personnel from the U.S. Embassy in Baghdad and consulate in Erbil,” said Helima Croft, global head of commodity strategy at RBC Capital Markets, in a Wednesday note.

See: U.S. orders embassy staff out of Iraq as Iran tensions rise

She was referring to a Tuesday attack on Saudi pipelines and other energy infrastructure. Iranian-backed Houthi rebels in Yemen said they were responsible for the attack (see map below).

See: ‘Sabotage’ attacks on Saudi oil tankers put Strait of Hormuz back in spotlight

The embassy and consulate evacuations in Iraq came after State Department warnings of heightened threats in the Middle East from Iran-allied militias, which could target U.S. citizens and soldiers in Iraq.

Earlier in the week, a U.S. official said Iran was likely behind weekend attacks on four tankers near the Strait of Hormuz, the world’s most important oil-transit chokepoint. Tehran has denied it was behind the attacks and accused the Trump administration and its allies of attempting to provoke a confrontation.

The U.S. last week dispatched an aircraft carrier group, bombers and other resources to the region, citing increased Iranian threats.

Nicholas Colas, co-founder of DataTrek Research, said in a note early Wednesday that investors did appear to be paying little heed to the rising tensions. Oil futures jumped sharply Monday but gave up the rally as U.S. stocks joined a global equity rout following China’s decision to retaliate against Washington for its decision on Friday to hike tariffs on Chinese imports.

Stocks, meanwhile, reclaimed some lost ground on Tuesday and Wednesday, trimming the weekly decline for both the S&P 500 SPX, +0.58% and the Dow Jones Industrial Average DJIA, +0.45%  to around 1.1%, encouraged by softer rhetoric on trade from the White House. Stock-index futures pointed to a higher start for Wall Street Thursday.

Oil, which has rallied so far this year, gained ground Wednesday, with Brent crude LCON9, +0.92%  ending at a two-week high above $71 a barrel, while the U.S. crude CLM9, +1.11%  also rose. But the rally remained relatively restrained, with Brent up around 2% for the week and WTI, the U.S. benchmark, up around 0.9%.

That indicates commodity markets have been discounting “Iranian saber-rattling, which means equity markets are paying little mind as well,” Colas said, adding that the reaction is “probably the right trade.

“Iran has been substantially weakened by sanctions. Saudi Arabia, its archrival in the region, has the full military backing of the U.S. And even if the Persian Gulf is temporarily harassed by Iranian military intervention, global oil markets should be well supplied,” he said.

At the same time, Colas said it’s worth remembering that energy shocks have ended more global economic expansions than any other event in the last 40 years. That includes the aftermath of the Saudi oil embargo in 1973-’74, the Iranian revolution in 1979, Iraq’s invasion of Kuwait in 1990 and the overthrow of Saddam Hussein in 2002-’03.

Indeed, oil analysts have warned that any sort of clash, while unlikely, could spark a jump in oil prices amid tight supplies. Analysts at JBC Energy, a Vienna-based consulting group, said a “full escalation” would likely drive crude back to the recent highs and possibly see them “spike beyond.”

Iran would have a very difficult time closing the Strait of Hormuz due to the presence of the U.S. Fifth Fleet in Bahrain, but does have ”the strategic depth to stage one-off attacks on vessels, not just in the critical chokepoints but also in the region’s relatively open waters,” said RBC’s Croft. “Not only do they have multiple naval outposts, but can work through proxies like the Houthis.

Colas said that while an oil shock seems like a remote possibility, investors could find being equal- or slightly overweight the energy sector relative to their benchmarks would cushion any blow to an equity portfolio.

Read: Why energy sector stocks aren’t keeping up with soaring oil prices

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