President Trump’s decision to start a war with Iran will likely negatively impact our economy and the financial markets if the war continues for several months. It will disrupt supply chains, fuel inflation, and limit the Fed’s ability to lower interest rates and help the Housing and Consumer markets. Our view has been that 2026 would be year of remarkable growth, but we now must weigh the ‘War Variable’ in deciding how the outlook has changed.

To evaluate the new Reward-for-Risk prospects we reviewed annual, historical market data back to 1928 to examine how the financial markets performed during past wars like WW2, the Korean, the Vietnam War and the eight-year Iran/Iraq war where the US was allied with Saddam Hussein. Except for WW2 when the stock market had double-digit, back-to-back, annual declines, investors who bought and held experienced rebounds a couple of years later. We then re-examined big market drawdown events and particularly looked at the 1971-1982 period. This was the time when the US defaulted on its pledge to back the Dollar with Gold (1971), the Yom Kipper War broke out with Egypt and Syria attacking Israel, the Arab oil producers initiated an oil embargo (1973) angered by the US backing Israel, and gradually high inflation became an established factor in the economy (1973-1982). Near the end of this period the Iranians overthrew the Shah of Iran (1979) who had been put in power by the CIA & MI6 in a 1953 coup d'état that overthrew their democratically elected government. Federal Reserve Chairman Paul Volker eventually raised interest rates until the Prime Rate surged to 21.5% in 1981. The economic impact of those high interest rates caused successive recessions and unemployment rose to 10.8% by 1982.

Last year, the Trump administration passed the One Big Beautiful Bill Act incenting business growth with tax cuts and accelerated depreciation benefits for building plants and investing in Research & Development. They also passed Social Security tax benefits for Seniors and interest deductions for consumers on new car purchases for personal use. The Administration has also streamlined permit regulations to ensure the US leads in Artificial Intelligence and Quantum Computing which are expected to provide a massive leap in productivity. But the Iranian war, like import tariffs, introduce uncertainties which cause businesses to pause their expansion plans until they have more detailed information to make good decisions. Our review found many factors of the 1971-1982 period to have ominous parallels with today.

It may be that President Trump will declare victory and an end to the war as he has called it an “excursion” and put a 4–8-week timeframe on it. Perhaps there is precedent to believe this will happen and in the meantime, the EU and US have announced plans to release oil from their strategic reserves to make up for the lost energy supply. No doubt this will temporarily suppress inflation and certainly the US is better positioned than Europe and Asia with its robust oil and gas production. But Iran views the war as an existential threat and is planning on a long, economic war. They know the cost of energy, ship insurance, and threats against tankers will disrupt global commerce and hurt the US economy. Meanwhile, China has a 25-year agreement with Iran to help them develop their energy resources. Russia has a strategic military agreement with Iran. The Arab states have seen their missile defenses destroyed by Iran who has warned them they are targets if they aide the US and Israel.

The US economy is currently in good shape as measured by factors driving our Gross Domestic Product. Manufacturing Outlook, Inflation, Fed Interest Rate Policy, Employment, Dollar Strength, Consumer Spending, and Corporate Earnings all remain stable albeit at slow growth. Housing is weak and Private Credit is tenuous, but not a takedown. War is inflationary however, and we expect this war factor to both erode consumer confidence and limit the Fed’s rate cutting pathway. Should the Fed cut rates in response to a slowing economy or recession, we expect doing so would lead to stagflation and perhaps inflation considering the US is also over-spending to the tune of $2 Trillion again. For this reason, we think it is prudent to reduce our equity exposure until more certainty about the Middle East war is evident.

Our rationale is that market corrections can result in a lot of wealth lost and while corrections differ by their triggers, the cumulative effect of what we see warrants taking less risk because the expected gains don’t exceed the potential loss. We realize clients have different objectives and some have time on their side to recover or are not taking income withdrawals. Our objective is to weigh Reward-for-Risk probabilities striving to keep money compounding. Please call us if you want to discuss your account management with us.