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Will Iraq be the trigger for a market correction?

Rising tensions in Iraq are pushing oil prices higher and that's giving investors anxiety.

Higher oil prices caused by political tensions are far different than higher oil prices caused by a robust global economy. A struggling recovery compounded by a rise in energy prices during the crucial summer travel season will cause investors to rethink their projections and assumptions.






Tribesmen, fighting alongside Iraqi police forces, hold a position in a street of the city of Ramadi, west of the capital Baghdad, on January 30, 2014 during a military operation against anti-government fighters.
Azhar Shallal / Stringer | AFP | Getty Images
Tribesmen, fighting alongside Iraqi police forces, hold a position in a street of the city of Ramadi, west of the capital Baghdad, on January 30, 2014 during a military operation against anti-government fighters.

And, if central banks start raising rates sooner than expected, it could catch many off guard as analysts and strategists re-assess the impact at a time when valuations are already a bit extended.

Read MoreI don't see a correction on the Iraq crisis: Gabelli CIO

In the last two weeks alone, we have seen oil jump 5 percent to $107 a barrel from $102 a barrel, spurred by the rising tensions in Iraq and the region. During this same time, U.S. equity prices have churned in place — not collapsing as many expected.

The speed at which this drama is unfolding is raising a lot of concern on the global stage as many worry about the ability of the current Iraqi government to control the escalation. It also raises concern about whether or not OPEC can meet world demand, which is estimated at an additional 700,000 barrel per day in the second half of 2014, as it is dependent upon increased output by Iraq. (Iraq is the second largest OPEC producer behind Saudi Arabia.)

If Iraq spins out of control and the insurgents succeed in moving closer to Baghdad, then expect oil prices to surge higher while equity prices move lower. Understand that some 90 percent of Iraq's oil comes from the south of the country, and although it is unlikely that the jihadists will succeed in moving south, just the potential for chaos will disrupt the status quo.

Transportation stocks will suffer and the broader market will come under pressure as oil prices start to skyrocket.

Read MoreEnergy stocks are getting hot — too hot?

But here's the real question: Will Iraq be the catalyst that brings on the correction or will any pressure lower prove to be short-lived? Remember: We are trading near the record highs, long-term asset managers are comfortable buying on the dips but see no reason to take stock on upticks.

I don't think Iraq will trigger a huge market pullback, though I do believe that the current geopolitical situation will prevent any further significant upside. Barring an all-out civil war in Iraq, I am confident that any weakness created by this crisis will be short-lived and will create an opportunity for buyers.

In a time of increasing geopolitical tensions, investors tend to disregard the macro data and focus on the tension until they feel more comfortable about the expected outcome. Until there is more clarity, investors want to know: Who is in charge? Will international oil firms close down operations and withdraw staff in order to protect their investments? Will continued insurgency draw the U.S. back into Iraq? All of these questions will cause investors to remain cautious and patient. So as the drama plays out, don't expect to see investors change their mentality until they have more clarity.

In addition, Wednesday's Federal Reserve statement will incorporate not only the most recent U.S. macro data points, it will also include the acknowledgement by the Bank of England that they may be the first central bank to raise rates.

Read MoreWill whiff of inflation prod the Fed?

This will be a test for Janet Yellen: How will she spin it? Can she keep the markets sufficiently calm in a time of international turmoil and economic malaise?

I do believe that Yellen will pull it off — I do not expect that she will say anything that the market (investors) do not already expect. And although Bank of England Governor Mark Carney did suggest that the BoE may be the first to raise rates sooner than expected, I think he was testing the water, testing investor commitment — much like Yellen and the Fed have done numerous times. Remember: They float the idea, they watch for market reaction and then revisit if investors begin to panic. That being said, I would not be surprised to see the market turn temporarily weaker on her comments.

Weaker does not mean panic.

Read MorePolcari explains 'quadruple witching'

Commentary by Kenny Polcari, director of NYSE floor operations at O'Neil Securities. He is also a CNBC contributor, often appearing on "Power Lunch." Follow Kenny on Twitter @kennypolcari and visit him at kennypolcari.com.

Disclosure: The market commentary is the opinion of the author and is based on decades of industry and market experience; however no guarantee is made or implied with respect to these opinions. This commentary is not nor is it intended to be relied upon as authoritative or taken in substitution for the exercise of judgment. The comments noted herein should not be construed as an offer to sell or the solicitation of an offer to buy or sell any financial product, or an official statement or endorsement of O'Neil Securities or its affiliates.

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