Could the US-Iran escalation sink the ASX 200? History says no

The US carried out targeted strikes on Iran's nuclear facilities over the weekend, dramatically escalating the Iran-Israel conflict and raising fears of a broader regional war. President Trump announced the strikes had obliterated Iran's nuclear enrichment capacity, branding Iran the "world's number one state sponsor of terror" while threatening further attacks unless Iran seeks peace.

Iran's Foreign Minister Abbas Araghchi called the US action "outrageous" with "everlasting consequences" and reserved the right to defend itself. The strikes have heightened concerns about potential Iranian retaliation, including closing the Strait of Hormuz — through which approximately 20% of global oil passes — along with attacks on US regional forces and cyber-warfare campaigns.

Yet despite these dramatic headlines, financial markets traded with surprising calm on Monday. The S&P/ASX 200 slipped just 0.36%, recovering from earlier losses of 1.00%. Brent crude briefly spiked 4.1% to US$80.34 per barrel before settling back to just 1.2% higher at US$78.11. Gold initially rallied 0.8% to US$3,398 per ounce as investors sought safe-haven assets but later retreated 0.48% to US$3,355.

This disconnect between alarming headlines and measured market reactions tells a familiar story — one that history tends to support.

Historical Context: How Markets Perform During Major Conflicts

Historical analysis reveals that the S&P/ASX 200 gains an average 13.2% in the year following major geopolitical events, assuming no major global economic collapse. Analysis of major conflicts since 1990 reveals a consistent pattern in the ASX 200’s performance across various time frames.

Source: Author's own research

The data highlights a bullish outlook. The ASX 200 is, on average, positive across all time frames and positive the vast majority of the time. While initial performance may be flat as events unfold, there's overwhelming positive performance after the first week. The gains are measured but show clear momentum building over time.

Why Markets Tend to Rise During Conflicts

Several factors explain why stocks tend to trend higher after wars break out:

• Resolution of Uncertainty: Markets hate uncertainty. When war breaks out, initial fear may cause a sell-off, but as the conflict's scope and impact become clearer, uncertainty diminishes. Investors regain confidence, and stocks often rebound as risks are priced in.

• Government Spending and Stimulus: Wars typically trigger increased government spending on defense and infrastructure, injecting money into the economy. This benefits industries like defense, energy, and logistics, which can lift broader market indices.

• Geopolitical Risk Premiums: Certain sectors, particularly energy and commodities, often see price spikes during conflicts due to supply disruptions. Companies in these sectors may experience higher profits, boosting overall valuations.

• Historical Resilience: Markets have consistently recovered quickly from geopolitical shocks, creating a precedent for investors to "buy the dip," especially when a conflict's economic impact appears limited or contained.

• Central Bank Responses: To stabilise economies during wartime disruptions, central banks often lower interest rates or provide additional liquidity, creating favorable conditions for stocks. The Federal Reserve's rate cuts after 9/11 exemplify this supportive response.

Current Risk Factors

Despite historical precedent favoring market resilience, several factors warrant caution in the current crisis. RBC Capital Markets Head of Global Commodity Strategy Helima Croft highlighted key risks:

Strait of Hormuz Vulnerability: Iranian officials have threatened to impede traffic through this critical oil route. While fully closing it would be difficult due to the U.S. Navy's Fifth Fleet presence in Bahrain, Iran could deploy missiles, mines, or asymmetric tactics to disrupt tankers and ports, similar to the 2019 Fujairah attack.

Regional Retaliation Capabilities: Iran retains short-range missiles capable of striking Gulf energy facilities and U.S. bases in Qatar, UAE, Bahrain, and Saudi Arabia. Attacks on U.S. personnel would cross a Trump "redline," though energy-related triggers remain less clearly defined.

Proxy Network Dynamics: Iran-backed militias in Iraq and Yemen's Houthis may hesitate to escalate due to fears of suffering the same fate as Hezbollah or Hamas. However, pressure from Tehran could force action if regime survival appears at stake.

Looking Ahead

The situation remains fluid, with wider escalation possible despite Trump's apparent "escalate to de-escalate" strategy. Experts warn against assuming the crisis has peaked, citing unpredictable factors in this nine-day conflict.

While history suggests markets may continue their resilient pattern, the current crisis presents unique challenges that could test this historical precedent. Investors should stay cautious while noting markets’ consistent ability to recover from geopolitical shocks.