The Biggest Market Obstacle: Oil Is Still Too Cheap

Oil Prices, Markets

Indexes are trading close to flat on Friday morning as investors wrestle with uncertainty over Iran, oil prices, and the economic repercussions of a conflict that shows no signs of a quick resolution.

As is typical when the market is under pressure, there are the usual folks trying hard to time the exact bottom. There is no way to do that effectively. No one knows how events in the Middle East will unfold or how President Trump will react.

The biggest problem the market faces is oil. Even if the Iran war ended tomorrow, there would already be a substantial supply disruption that would take months to fully fix. The Strait of Hormuz is effectively closed and partially mined but Brent crude is trading around $101 a barrel on Friday morning.

After the Iranian revolution in 1979, the inflation-adjusted price hit $179. Iraq's invasion of Iran in 1980 produced a price of $155 and in the Arab Spring it hit $180. Russia's invasion of Ukraine in 2022 produced a spike to $130.

So why isn't oil much higher, given the much greater disruption this time?

Three Reasons the Price of Oil Is Still Relatively Low

The Wall Street Journal provides some insight into why oil is not more expensive. It started from a low base. Storage was at a five-year high and the price was only $72 before the events in Iran began. There was some room to absorb the initial shock.

The 40% rise in the first nine trading days of the war is comparable to past spikes during the Arab Spring and the Russian invasion of Ukraine, but the most important issue is that Trump keeps hinting that the war in Iran is going to end very quickly and the price of oil will normalize.

That scenario is under close scrutiny and is the cause of the high volatility over the last two weeks. Stocks bounced sharply when the Polymarket odds of the war ending by March 31 jumped from 20% to 43% in a matter of hours following some Trump comments. However, as of Friday morning, those odds have collapsed back to where they started, and Polymarket now puts the probability of military action continuing through the end of the month at 84%. In addition Goldman Sachs has raised its estimate for Hormuz disruption from 10 days to 21 days and that may likely expand.

The coordinated release of 400 million barrels by IEA members is helping to relieve some of the pressure on oil prices. However, that release represents less than a month of replacement supply and will be depleted quickly if prices continue to move higher.

The Assumption Driving the Market Action

The S&P 500 is down only about 3% from its pre-war close. Like the oil price, that relatively modest decline depends almost entirely on a single assumption: this is a short war. If that assumption is correct, the disruption is temporary, then long-term earnings and growth prospects are still in place and the market is healthy.

In addition, this has been a rotational correction, and many individual stocks already have deep corrections. The indexes are not doing a good job of indicating what is really going on, but the fact they are not lower is a major problem because it sends the message that investors are not fully grasping the gravity of what is happening with Iran and oil.

My Game Plan

All of this reinforces the same conclusion I have been discussing all week. Trying to predict a bottom here is extremely dangerous. No one rang a bell when the first Gulf War ended or when oil peaked in 1980. The resolution came and the market moved before most investors had time to react.

What makes the current situation particularly tricky is how well the market has held up. A market that has not fully priced a bad outcome has considerably more room to fall if that outcome materializes than one that has already been through genuine panic and capitulation. The relative calm in stocks is not a signal that the worst is behind us. It reflects the assumption that the worst does not happen.

The only effective strategy here is patient preparation. Do the research. Build a shopping list. Hold the small core positions in the names you want to own in size. Then wait for the market to confirm that conditions have changed rather than trying to anticipate it. When the resolution comes, it will likely be fast. It will reward the prepared far more than the impatient. As Louis Pasteur said, "Fortune favors the prepared mind."

At the time of publication, Rev Shark had no positions in any securities mentioned.