Investors have seemed perfectly content to ignore geopolitical risks for much of the past year.
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But as of Thursday afternoon in New York markets, the situation appeared to have changed, with Israel not bracing for a military attack from Iran to trigger a sharp reversal in stock prices, according to analysts at Bespoke Investment Group. He pointed out the speculation.
Israel demolished the Iranian consulate in Syria earlier this week, leading to a rise in oil prices.
Some market analysts now believe that the Middle East powder keg could ultimately hurt stocks more than the Fed’s delayed start to cutting interest rates, and that geopolitical risks will only rarely have a lasting impact on markets. He warns that this could become an example.
Steve Sosnick, chief market strategist at Interactive Brokers, said in an interview with MarketWatch that “equity investors are not very good at assessing geopolitical risk and how it impacts markets. ” he said. “He’s one of those things that tends to fade into the background until all of a sudden it’s gone. Then when they start paying attention, we can end up overreacting.”
U.S. stock indexes ended Friday higher but fell by Thursday afternoon, with the Dow Jones Industrial Average DJIA giving up big gains and falling 530 points, according to Dow Jones Market Data. It ended with the biggest single-day decline in more than a year.
U.S. Treasury yields rose on Friday but fell on Thursday, despite comments from Minneapolis Fed President Neel Kashkari suggesting the Fed could keep interest rates on hold until next year. For Bespoke’s team, the slow reaction in bond yields was a sign that concerns about escalation in Iran, rather than changes in the interest rate outlook, were the main driver of the stock decline.
Considering this, it is worth considering why, six months after the start of the Israel-Hamas war, stocks suddenly seem to be reacting to tensions between Iran and Israel. The stock market initially shrugged off the Hamas attack on Oct. 7, and ended Oct. 9 with the S&P 500 SPX higher, according to FactSet data.
One reason investors tend to be unresponsive to geopolitics is that geopolitics rarely has a lasting impact on corporate earnings, says BofA Global Research’s head of U.S. equities and quantitative strategy. said Savita Subramanian, who discussed this topic in a report released shortly after the Hamas attack. Unless geopolitical shocks impact the underlying economy, the resulting market declines tend to be short-lived, presenting investors with an opportunity to buy momentum after a 5% to 10% decline. Yes, he said.
Major geopolitical events of the past three decades, such as the Sept. 11 terrorist attacks and the Brexit vote, had only a temporary impact on the market, Subramanian noted.
Even the shock of the Russia-Ukraine war has faded as oil prices retreat from their peak around $130 a barrel. The Fed identified supply chain problems caused by the coronavirus pandemic as a key factor in the wave of inflation that rocked markets in 2022, while the Biden administration initially blamed Russia.
However, a broader conflict in the Middle East involving Israel and Iran could cause a level of economic damage that would force investors to react.
Given the large-scale production activities in the Middle East, rising oil prices could become an obvious problem. Abundant U.S. oil supplies should cushion the backlash for U.S. consumers, but Subramanian said another energy shock could lead to further disruptions in global trade, reduced demand for international travel and a weakening of European consumers. The move could hurt the profits of U.S. multinational companies and put pressure on Europe, it said. Entering a recession.
All these factors could cause global stocks to remain depressed for months or more, Subramanian said.
Certainly, there are market sectors that could benefit, such as the defense and aerospace industries. SPDR S&P Aerospace & Defense ETF XAR is off to a sluggish start to 2024, up just 1.7% year-to-date as of Friday. Energy companies could also benefit from higher oil prices.
Ed Yardeni, president and chief market strategist at Yardeni Research, has long warned that investors should not discount the risks of conflict in the Middle East. He cited the possibility of regional war as the main risk to the generally bullish market outlook.
Yardeni issued a new warning Friday, saying that if tensions between Israel and Iran metastasize into a broader conflict, the 2020s could end up resembling the 1970s, when stock markets famously underperformed. In a note to customers, the company stated that there is a possibility that
“Historically, geopolitical crises have been buying opportunities for many years. But rather than subside, this crisis in the Middle East is getting worse,” Yardeni said in an interview with CNBC late Thursday. .
U.S. stocks ended higher on Friday, with the S&P 500 up 57 points, or 1.1%, to end at 5,204, the Dow Jones Industrial Average up 0.8% and the tech-heavy Nasdaq Composite Index up 1.2%. Rose.
All three indexes still ended the week lower, with the Dow Jones Industrial Average having its worst week in a year. Last week’s rise in oil prices and rising U.S. Treasury yields have also contributed to the recent decline in stock prices.
Yardeni believes the risk of broader conflict in the Middle East is a bigger threat to markets than the Fed’s choice to keep interest rates on hold for the remainder of 2024.
“Geopolitics is my biggest concern. It doesn’t worry me because it’s consistent with my view that the economy is resilient even if the Fed doesn’t lower interest rates,” he told CNBC.
