Decoding Markets: Geopolitical Fear

Estimated reading time: 5 minutes

Energy Jitters

“The more things change, the more they stay the same” — that famous saying certainly seems to apply to financial markets of late. Nearly halfway through 2025, investors have weathered significant global trade upheaval, major artificial intelligence developments, and military conflicts, yet the S&P 500 is near its all-time highs while the tech-heavy Nasdaq 100 has already surpassed its prior peak.

The most recent instance of this proverb can be seen in the recent conflict between Israel and Iran. The initial escalation of hostilities began two weeks ago, when Israel launched airstrikes against Iran, targeting military and energy infrastructure, and culminated in the U.S. joining in to bomb nuclear facilities.

All of this triggered a classic fear-based response in energy markets, with crude oil prices surging over 15% to a five-month high as traders priced in the potential for a severe supply disruption. But almost just as rapidly as prices spiked, they have declined in the days since.

WTI Oil Prices

By targeting a U.S. military base in Qatar while giving advanced notice of its intent to retaliate, Iran signaled a desire to deescalate. Combined with news of a U.S.-brokered ceasefire and the desire for an end to the conflict from President Trump, fears of further escalation have eased.

Though oil prices are back to where they were earlier in the month, things feel more fragile now. The closure of the Strait of Hormuz remains a major risk for energy markets. While investors see that as unlikely — given Iran’s oil-dependent economy and because such a move could alienate its primary customer, China — estimates suggest any disruption could send prices soaring over $100 per barrel.

Being Greedy When Others Are Fearful

For many investors, the instinctual reaction to rising geopolitical risks is to reduce market exposure, yet history provides a compelling contrarian take. To quantify this, we can use the Geopolitical Risk (GPR) Index, which measures the frequency of news articles mentioning negative geopolitical events.

While overall market returns are varied and don’t have much of a clear pattern, there are notable patterns once we look deeper. In particular, cyclical stocks have historically outperformed defensives after spikes in geopolitical risk.

Relative 1-Year Forward Performance of Cyclicals vs. Defensives
Improves as Geopolitical Risk Increases

The drivers of this phenomenon aren’t exactly the same across history, but the pattern is rooted in market psychology and the economic cycle. The initial reaction to any sort of crisis is often a flight to safety, which can temporarily boost defensive stocks as investors seek stability, and hurt stocks that are more sensitive to economic conditions.

It’s uncommon for geopolitical events to meaningfully affect underlying fundamentals, however, so as the market digests the event and worst-case scenarios fail to materialize, a recovery often takes hold. Historically, this rebound is led by more economically sensitive, and usually oversold, cyclical stocks.

Internal Market Compass

Short-term price action can swing wildly depending on technicals and the news of the day, but fundamentals are what durably drive markets. And the fundamentals are looking a bit iffy right now. How will tariffs affect the economy and inflation? What will the final budget reconciliation bill look like? 

For what it’s worth, the Federal Reserve’s recently released projections show lower GDP growth, higher inflation, and higher unemployment through year-end. But given all the macro crosscurrents, things could change quickly. That’s a tough scenario not only for central bank officials — do you prioritize price stability or the labor market? — but for consumers and businesses as well. 

Even though the headline stock indices might not show it, the market looks more cautious under the surface. Only 4% of constituent stocks are at 52-week highs. Compare that to last year when the metric was routinely in the 10-20% range, and it becomes clear that investors are still not fully buying the story of a durable bull market.

Percent of S&P 500 Stocks at 52-Week Highs

Where things will go from here is anyone’s guess. We won’t know if the bull market is truly intact for at least another month, when firmer data about tariffs and corporate earnings finally arrives. In the meantime, as another famous saying goes, “anything can happen.”

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