Markets have been volatile since the United States and Israel started military strikes on Iran on Feb. 28, but the fallout may not be as bad as feared.
 

Markets are still “relatively well behaved,” said Philip Petursson, chief investment strategist at IG Wealth Management. The caveat? The longer the war goes on, the worse the outlook is for equity markets and the global economy as a whole, he said.

“Every day that oil prices are at this level, every week that goes by, if this stretches in two months, then the risk of recession increases,” he said.
 

The U.S. market is showing “resilience” compared to others, said Craig Basinger, chief market strategist at Purpose Investments. International stock markets, including Europe and Asia, have been hit harder because they’re more exposed to global trade upheaval and rely heavily on oil from the Middle East.
 

“People are concerned about if this is going to have a broader economic impact. And as a result, that’s hitting markets that have more economic sensitivity,” Basinger said.
 

While energy stocks make up 16 per cent of the S&P/TSX Composite Index, higher oil prices didn’t shield the index from Monday’s global selloff. Looking at energy stocks and energy futures positions, Petursson said investors don’t seem to be pricing in higher oil prices sticking around for a long time. 
 

“You would have thought oil getting to $90 a barrel would have provided a nice pop for the energy producers, but it’s been rather muted, so that tells me that the energy investors are saying this is probably going to be short lived,” Petursson said.
 

Coming off three years of a bull market, a slump of a few per cent is relatively small in the grand scheme of things. Even if the TSX loses 10 per cent from its all-time high in March, Petursson said, it would be back to levels seen in December. If the S&P 500 drops 10 per cent from its January high, it would be roughly at the same level as last August.
 

The greater concern, he said, is how persistently high oil prices are a headwind to economic growth and a “tax on the consumer.” Petursson said the worst-case scenario is the least probable — a drawn-out conflict that constricts the global energy supply chain and keeps oil prices high for a prolonged period of time.
 

“We would need to see oil in the $140 range to be really, really negative for the global economy. We’re not there yet,” Petursson said. “Who’s to say if we’ll get there or not? But if we were to get closer and closer to that, then the recession risk and the more meaningful downside of the equity markets would be a higher risk overall.”
 

David Rosenberg, president and founder of Rosenberg Research, said high oil prices could cause short-term statistical inflation but he doesn’t expect it to over the long term.

He said sharp spikes in oil prices “end up sowing the seeds of their own demise” by causing a contraction in aggregate demand, which then spreads to buying activity in the rest of the economy and creates a disinflationary environment — as occurred during the Gulf War in 1990-91.
 

“That whole episode lasted six months, and the oil price went from $15 to $40 in that period and inflation spiked,” Rosenberg said. “But within a year after the end of the war, and this was back in 1991, inflation ended up coming down below where it was before the war started.”
 

Basinger said the market has been “fragile,” even before the war in Iran war started, as it rotates away from growth stocks, the price of gold surges and retreats and economic cyclicals and defensives perform well at the same time, which is unusual.
 

Rosenberg said there are other concerns for the market, including the risks posed by corporate credit and private debt, how artificial intelligence is disrupting a swath of other sectors and the state of the U.S. economy after last week’s non-farm payroll report revealed unexpected job losses and a higher unemployment rate in February.
 

“We’re going to bounce back, but then we’re going to go back to the same sort of wobbly market we had before all this happened,” Rosenberg said. “We’re just going to eliminate a giant tail risk.”

• Email: jswitzer@postmedia.com

  • This TSX stock fought its way back from the AI software rout and may have ‘strong growth prospects’
  • The optimal path for investors to achieve long-term outperformance