Geopolitical tensions have long been a critical factor influencing market movements. From wars to political unrest, these events can send shockwaves through global markets, often leading to significant corrections or even crashes. Two such instances—one in 1973 and another in 2022—highlight how geopolitical tensions can trigger major downturns in the S&P 500. With today’s headlines hinting at potential conflict in the Middle East, many are asking: could history be repeating itself?
The Yom Kippur War and the 1973 Market Crash
The year 1973 marked a pivotal moment in financial history. The S&P 500 began to trend lower as investors grew increasingly concerned about rising geopolitical risks in the Middle East. These fears were realized in October 1973 when the Yom Kippur War broke out, leading to a rapid escalation in oil prices. The war, which pitted Israel against a coalition of Arab states, caused a significant disruption in oil supplies, sending prices soaring.
As oil prices surged, the impact on the global economy was profound. The S&P 500, reflecting the broader economic turmoil, suffered a massive 40% decline over the next year. This market crash was a direct consequence of the energy crisis, highlighting the powerful connection between geopolitical events and financial markets.
The 2022 Ukraine Invasion and Market Response
Fast forward nearly five decades to January 2022, and the world witnessed a similar pattern. The S&P 500 again began to decline as investors grew wary of rising geopolitical risks—this time in Eastern Europe. By February, Russia had invaded Ukraine, leading to another spike in energy prices. The market responded predictably: after a brief bounce, the S&P 500 entered a sustained decline, ultimately falling by 20% over the following year.
The parallels between 1973 and 2022 are striking. In both cases, geopolitical conflicts led to a surge in oil prices, which in turn drove significant market downturns. These events serve as stark reminders of how sensitive financial markets are to geopolitical instability.
Today’s Market: A New Geopolitical Tension?
In recent months, global markets have once again corrected sharply. This time, the trigger appears to be rising concerns about potential conflict in the Middle East. With news headlines increasingly focused on the region, many investors believe the recent market downturn is linked to these geopolitical risks. If history is any guide, we could be on the verge of much larger drawdowns, accompanied by soaring inflation if the war materializes.
The question now is whether today’s market situation is comparable to 1973 or 2022. To answer this, it’s important to consider how the market is currently pricing in geopolitical risks.
Measuring Geopolitical Risk: The Role of the GPR Index
One tool that we use to gauge geopolitical risk is the Geopolitical Risk (GPR) Index. This index measures media-driven panic across eight categories of threats, pulling data from ten major newspapers. It’s a useful barometer for understanding how much fear is being generated by geopolitical events.
Throughout 2023 and 2024, the GPR Index has shown several spikes, particularly in response to events in the Middle East. For example, the killing of a Hamas leader in August 2024 led to a notable increase in the index.
However, this spike, while significant, was still significantly lower than those observed during the 2022 Ukraine invasion, suggesting that the market has not yet fully priced in the potential risks.
Oil Prices: A Key Indicator to Watch
One of the most telling indicators of market sentiment during geopolitical crises is the price of oil. Historically, rising oil prices have been closely linked to market downturns, primarily because they lead to higher inflationary pressures. When oil prices rise, production costs increase, squeezing corporate profits and consumer spending power—both of which are negative for stocks.
Recently, oil prices have been trending down, reflecting a lack of immediate concern about the Middle East situation. However, if tensions escalate, we could see a breakout in oil prices, which have been relatively stable. Such a breakout would likely lead to a significant market correction, similar to what was observed in 1973 and 2022.
Potential Economic Consequences of a Middle Eastern Conflict
Should oil prices spike to $100 per barrel as a result of a conflict in the Middle East, our research shows that a recession would be almost guaranteed. Historically, every significant spike in oil prices—above 30%—has been followed by a recession in the United States within the following year. The only exception was 2022, when the economy was cushioned by $3.5 trillion in excess savings left over from the pandemic. Today, however, that buffer no longer exists, making the economy more vulnerable to an oil shock.
Recessions are not a good environment for stocks. Historically, the average market decline during a recession is about 30%. This makes the current geopolitical situation critical to monitor
One key indicator we’re watching is oil prices. If oil breaks out above its downtrend line, it would signal worsening conditions in the Middle East and that would likely trigger an economic downturn in the US. Right now, oil prices are trending down and inflation expectations have significantly lowered, which is a net positive for the market. Lower inflation would allow the Fed to start cutting interest rates and that would likely have a positive impact on the stock market as far as a recession doesn’t unfold immediately.
However, pinpointing the exact start of a recession is notoriously difficult. We know we’re getting close, but with the market still in a strong uptrend, it’s too soon to turn bearish. In fact, we’ve seen increasing signs that the market could have another leg higher, Therefore, we used the recent correction to increase our equity exposure, positioning ourselves for what could be another market upswing.
Conclusion
Geopolitical risks have always been a significant driver of market volatility, and today’s situation is no different. The potential for conflict in the Middle East, coupled with its historical impact on oil prices, suggests that the markets could be in for a rough ride if this war materializes. As we’ve seen in both 1973 and 2022, when geopolitical tensions rise, so do the risks of a market downturn. Investors would do well to monitor these developments closely, keeping an eye on key indicators like oil prices and the GPR Index. Whether the market continues its recent correction or rebounds for another leg higher, the geopolitical landscape will play a crucial role in determining the outcome. Click here to sign up! Subscribe to our YouTube channel and Follow us on Twitter for more updates!
