CONTRIBUTORS
Stephen Dover, CFA
Head of Franklin Templeton Institute
This weekend, the US military struck Iran’s facilities linked to its nuclear ambitions. The escalation of what had previously been an Israel-Iranian conflict marks a significant change, with important near- and medium-term global implications.
Specifically, the risk has now increased that Iran may attempt to broaden the conflict, potentially by striking at US military targets in the Middle East, at oil and gas production facilities of US allies, or by interdicting the flow of crude oil via the Straits of Hormuz.
In our assessment, however, Iran’s military leadership and capabilities have been significantly degraded by the ongoing conflict. Moreover, Iran’s leadership clearly recognizes the risks—indeed the military futility—of simultaneously taking on the United States and Israel in direct combat. Attempting to close the Straits of Hormuz would also shut Iran off from the earnings it derives from its crude oil exports, especially to China. This is a fluid situation and one we continue to monitor.
Nevertheless, oil futures prices jumped 2% prior to the opening of markets in Asia on Monday, and as of this writing, equity futures are mostly pointing lower, albeit modestly. The initial market reaction is one of caution, with moves toward traditional safe havens. In the short term, and during uncertainty, we expect investors to gravitate toward energy and global defense stocks as well as perceived safe-haven assets like gold and US Treasurys. The US dollar, also considered a haven, has risen slightly. In our view, interest rates are now more likely to come down, perhaps shielding higher-valuation growth stocks. Unless oil prices significantly increase, we believe a big impact on inflation seems unlikely. Still, if it becomes clear that the conflict won’t escalate more broadly, we anticipate that market weakness is apt to be short-lived.
Over the longer run, however, investors must also consider the following implications.
First, Iran’s inability to defend itself from attack will, if anything, underscore its desire—as well as that of other countries in other regions—to develop credible deterrence. And that likely means nuclear weapons. For countries unsettled by and vulnerable to regional conflict, in our view, the desire to acquire nuclear weapons as a deterrent will, if anything, only grow.
Second, while Iran appears unlikely to strike back directly at the United States anytime soon, at some point it likely will, whether by proxy or other means.
Third, and as we have written elsewhere, the unilateral withdrawal of American hegemony—notwithstanding this weekend’s military operations—leaves many countries and regions less secure about their national defense. The growing risk of conflict in all parts of the world reinforces the need nearly everywhere to increase spending on national defense, with all that implies for the suppliers of military hardware and the technology that underpins it. That shift is plainly underway in Germany and across much of Europe, and it will only gather momentum elsewhere.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments.
Strategies that invest in companies in a specific country or region may experience greater volatility than a strategy that is more broadly diversified geographically.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
WF: 5913858