Stocks May Survive War - But What Happens To ETFs At $120 Oil?

Wall Street's initial response to the latest escalation in Iran has a clear message: geopolitics, in itself, is not a big enough deal to derail the U.S. stock market. At least, not according to Wall Street strategists.

• What’s behind XLE new highs?

Per Bloomberg, Morgan Stanley's Mike Wilson wrote a note to clients that past geopolitical shocks have typically failed to produce sustained volatility for U.S. stocks.

Unless oil prices jump in a "historically significant manner," there is little reason to change a positive six- to 12-month stock market outlook, he noted.

That framing creates a clear ETF battleground: broad-market exposure versus energy hedging.

Broad ETFs Hold The Line

Historical patterns suggest the S&P 500 will stabilize in a matter of months after a geopolitical escalation. As such, broad-based ETFs such as the SPDR S&P 500 ETF Trust (NYSE:SPY) or the Vanguard S&P 500 ETF (NYSE:VOO) are a real-time gauge of whether or not the stock market is indeed buying the dip.

The variable to watch: energy prices.

Why $120 Matters

Although Morgan Stanley did not indicate what level of pricing was of particular concern, markets do have a reference point.

In the initial phases of the Russia-Ukraine War, Brent oil prices went beyond $120 a barrel briefly, raising concerns about inflation. Equity volatility surged significantly in response to a reassessment of growth and policy expectations.

More recently, around mid-year 2025, analysts at JPMorgan Chase had warned a severe and prolonged energy supply disruption in the Middle East, particularly through the Strait of Hormuz, has the potential to drive oil prices back to this range.

Any sustained move around the range $100 to $120 has the potential to escalate a geopolitical risk to a macro risk.

Energy: Hedge Or Head Fake?

If crude prices are sustained at high levels, energy ETFs could become the preferred hedge.

The Energy Select Sector SPDR Fund (NYSE:XLE) offers exposure to integrated majors and refiners that benefit from higher prices, while the United States Oil Fund (NYSE:USO) provides more direct commodity exposure.

The question for ETF investors is whether the current rally reflects a structural supply shock or a headline-driven spike that fades as tensions stabilize.

The Quiet Defensive Rotation

Health care is another area emerging as an area of focus.

Wilson has identified the sector as an area that is preferred as a defensive play, citing reasonable valuations, improving earnings trends and easing policy headwinds.

ETFs such as the Health Care Select Sector SPDR Fund (NYSE:XLV) and the Vanguard Health Care ETF (NYSE:VHT) could attract investors seeking downside protection without exiting equities entirely.

The sector has underperformed the rally in the artificial intelligence-driven megatech sector, as well as the broader equity market, over the past year. A sustained rise in oil prices on top of already elevated growth positioning could cause the sector to rally.

Nonetheless, RBC strategist Lori Calvasina warned investors not to blindly follow the traditional "buy the dip" approach, which may have worked in the past.

The conflicts have not always been as widespread as in the past. Bloomberg cited Calvasina, who cautioned the “technically correct” idea had historically worked in "more limited" conflicts, indicating it might not be the case this time around.

Markets are not influenced only by geopolitical issues in isolation. Other factors such as oil, inflation and earnings are also important.

For ETF investors, this isn't simply about conflict in the Middle East.

It's about whether crude stabilizes or climbs into territory that history suggests markets can't ignore.