U.S. stocks indexes are at or near all-time highs as the conflict in Iran and around the Middle East enters into the third month.  Stock investors seem to not care too much about what is happening in the Middle East.

The S&P 500 keeps posting record highs.  The Dow is almost back at 50,000.  Pam Bondi won’t have to trouble herself with the Epstein files again.

As I warned after the war against Iran began, war is not necessarily bad for stocks.  If you look back to 2003 with Iraq, it was actually the end of a bear market in stocks.  I’m not saying that war is necessarily good for stocks either, but it doesn’t seem to hurt them as long as the fighting is taking place somewhere far away.

However, I do think that investors are overly bullish here.  The death and destruction in Iran is tragic, but that in itself would not impact investment much in the United States.  But with the conflict, we have a drastic reduction in the supply of oil coming out of the Middle East.

Higher Oil Prices and Stocks

While war itself is inflationary, which can be good for stocks, rising oil prices is not by itself inflationary.  An increase in the supply of money is the inflation.  And the Fed is actually pursuing a slightly tighter monetary policy than it otherwise would have because of the spike in oil prices.

With the higher costs of energy, it actually can have a deflationary effect elsewhere.  If you have to spend 50% more to fill up your car, you might decide not to eat out as much.  You might decide to forego that nice jacket you saw in the store.

If anything, higher oil prices give us a better chance of a recession because it reduces the living standards of most people.  They are forced to save less or cut back in other places.

This can include having less money to buy stocks.  And, of course, it can also hurt businesses that sell services and products where there is reduced demand.

Even if the War Ends

The messages coming out of Trump and his administration are completely erratic.  They are usually untruthful at this point.  One day, we are close to an agreement.  The next day, Trump is threatening to end an entire civilization.  The next day, we are close to an agreement again.

One day, the Strait of Hormuz is supposedly opening up.  The next day, Iran says it is still closed and will stay closed until the U.S. calls an end to the war.

It is funny (in a sick way) that the main goal of the Trump administration now is to open up the Strait of Hormuz.  The Strait was open in February until Trump and Israel started bombing Iran for no legitimate reason.

The market reacts to all of this news and goes up and down, along with oil prices.  But it is kind of ridiculous at this point because almost everything is a lie.  Trump will just make up that we are close to an agreement even when there haven’t been any talks with Iranian officials.

Even if the war ended tomorrow, there has been much damage done.  Iran now controls the Strait of Hormuz and will probably continue to charge a toll to go through.  Even if shipping got back to where it was in the next few months, that is a lot of time to pass for a severe reduction in the flow of oil.

The marketplace is amazing at adjusting to these things, so things could get better in a relatively short amount of time.  But still, how can investors say that we are no worse today (in terms of company profitability) as compared to two months ago?

Stocks vs. the Economy

Again, this is with the best-case scenario with the war ending and the Strait of Hormuz opening up.  What if the conflict gets worse?  What if most of the bombing is over but we still get a closed Strait for the next several months or longer?

If the average price of gas goes to $5 per gallon (and we are getting close), how is that consistent with all-time highs in stock indexes?

The market can stay irrational longer than we can stay solvent.  But at some point, reality is going to hit.  Stocks are not a reflection of the overall economy at this point.

If this conflict doesn’t come to an end soon, it will be hard to believe that stocks will keep roaring higher.  Investors are happy right now.  The average American isn’t happy with increased prices at the pump.  There is a disconnect.