Stocks Swoon, Crude and VIX Spike as War Erupts

By Joe Mazzola

Crude oil and volatility surged this morning and major indexes fell about 1% after war erupted in the Middle East. In cooperation with Israeli forces, the U.S. began an attack on Iran Saturday that resulted in the death of Supreme Leader Ayatollah Khamenei and other casualties. The violence has investors scurrying for perceived "safety," though no investment is truly safe. This shift could lead to near-term strength in "defensive" sectors like staples, small caps, and utilities with less exposure to geopolitical currents. The benchmark U.S. 10-year Treasury note yield briefly fell below 3.94% over the weekend for the first time since October 2024 as investors flocked to where they saw lower risk.

The war could hurt airline, shipping, and delivery firms that might face disruptions and higher costs, and give defense contractors and energy companies a lift. Risk-sensitive assets like cryptocurrencies could also see pressure. Though turbulence could continue depending on how long the conflict lasts and its effect on oil shipping, investors should keep in mind that geopolitical conflict often has a short-lived impact on markets, which, so far, are holding together relatively well, without signs of panic. While the initial move is relatively contained overall, "second order" effects on the economy will matter, too. Higher energy prices can tighten financial conditions, which could pressure consumer spending, not to mention margin issues in energy-intensive sectors. There could also be a quick upward adjustment in inflation expectations and a resulting adjustment to expectations around the Federal Reserve's rate path.

On Friday, before violence flared, major indexes wrapped up a tough February that featured slight descents for both the S&P 500 Index and the Nasdaq-100^® (NDX). Defensive areas including health care, staples, and utilities rose, with eight of 11 sectors ending the day higher. Financials and tech were well in the red, keeping the S&P 500 down but above technical support near the 100-day moving average of 6,830. South of that is the 6,750-6,775 area, which was tested several times in recent months. A break below this level could trigger short selling activity.

Four things to watch

Assessing bullish, neutral, and bearish market cases for Iran conflict: At this point, considering the various scenarios about how the current situation could evolve is the best approach, said Chris Ferrarone, head of equity research and strategy at the Schwab Center for Financial Research (SCFR).

1. Under the neutral case of de-escalation and a stable Strait of Hormuz, oil prices are expected to trade in a range around pre-crisis prices, providing a neutral backdrop for global equities and credit markets in this scenario, episodes of volatility are likely to persist as deescalation plays out, Ferrarone said.
   
2. In adverse scenarios involving supply outages or an extended closure of the strait, oil prices could spike well above $100, leading to stagflation risks and heightened financial volatility, Ferrarone said. However, high spare capacity and diversified global supply could reduce the likelihood of catastrophic outcomes, he said.
   
3. A rapid resolution accompanied by a regime collapse in Iran could be a bullish surprise for risk assets—though regime change at this point seems a complicated and uncertain process, he said. In that optimistic scenario, the removal of the geopolitical risk premium could push oil prices lower than their pre-attack price below the prior baseline—and spur rallies in equities, particularly in Asia Pacific and Europe. Safe haven assets would likely decline, and central banks could accelerate rate cuts as energy prices fall, Ferrarone said.
   
4. In the short term, uncertainty is likely to prevail, and investors are likely to react by preparing for an adverse scenario. "Don’t overreact to the news," said Kathy Jones, chief fixed income strategist at SCFR. "A diversified portfolio should be able to withstand volatility in the short term. If investors are not well diversified, it might be time to look at portfolio allocations. But it probably isn't a good time to swing for the fences, given the wide range of potential outcomes. The past isn't necessarily a perfect guide to the future, but previous experience tells us that staying the course during times of heightened global risks, generally, is the right strategy."

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