Our Top Market Takeaways for October 20, 2023

Market update: Are markets ignoring the geopolitical risks?

It’s been almost two weeks since news broke of the Israel-Hamas conflict, and the fallout continues.

The human toll has been devastating. Diplomatic efforts also seem to have broken down after an explosion at a Gaza hospital. Iran’s foreign minister called for an oil embargo against Israel, Israel’s defense minister suggested a ground invasion into Gaza may come and the United States and other countries have advised their citizens to leave nearby Lebanon.

Many seem to be questioning the prospect of broader escalation.

Yet, markets haven’t moved as you might expect. Are they ignoring the geopolitical risks?

In short, we don’t think so. Markets seem to be very aware of the conflict unfolding in Israel and Gaza and are accounting for what’s known so far. Things could change if the situation escalates (as we discussed last week), but as of now, markets are behaving roughly in line with past geopolitical events, with greater emphasis on the broader economic backdrop and business cycle.

Today, we take a deeper look at the price action.

The assets closest to the conflict have moved the most.

Since the conflict began up to today (heading into Friday morning), Israel’s currency – the shekel – has weakened over 5% versus the dollar, and prices for both oil and safe haven gold have spiked around 10%.

That signals some worry, but not necessarily the greater risk of a broader conflict. By comparison, the 1973 Yom Kippur War (50 years ago this month), involved a wider group of nations and an oil embargo by Arab OPEC countries that had dramatic consequences. As the embargo meaningfully disrupted supply, it catalyzed oil prices to soar over 300%, inflation to surge, a recession to unfold and stock markets to fall into a prolonged rout.

Given that there isn’t any evidence of similar actions being taken today, and neither side in this conflict are meaningful oil players, markets haven’t needed to recalibrate. That said, we are monitoring escalation risk closely – especially a scenario that formally pulls Iran, which produces 4% of global oil supply, into the fold.

Line charts showing the price of Brent crude oil and Gold, as well as the start of the Israel-Hamas conflict.

When it comes to broader bond and stock markets, different drivers seem more at play.

10-year U.S. Treasury yields surged further this week, within touching distance of 5%. Yet, longer-dated bond yields have been climbing since May (well before word of the conflict hit), and a confluence of factors seem to be at play:

  • Growth: The U.S. economy probably grew 3% or more in the third quarter. The labor market is still humming. The consumer is still spending. And, capex around industrial policy is creating powerful tailwinds.
  • Monetary policy: Because growth has been strong and inflation sticky, policymakers have resolutely signaled they intend to keep rates “higher for longer.” So while the Fed may be done (or nearly done) hiking, tightening isn’t over.
  • Fiscal deficits: The U.S. Treasury has had to issue more bonds this year than expected to finance the government’s deficit. Now, as President Biden prepares to ask Congress for more funds (in the billions of dollars) to offer aid to Israel and Ukraine, this has been even more in focus. All else equal, more Treasury supply puts downward pressure on prices and upward pressure on yields.
  • Washington dysfunction: The drama continues, and the House has now been without a Speaker for 17 days. That doesn’t incite much confidence for policymakers’ ability to tackle both short-term spending needs and long-term debt problems, especially as we barrel towards the November 17 budget deadline to avoid a government shutdown.
  • Technical market factors: Positioning, momentum and trend-following strategies all also seem to be exacerbating the moves over the last few months.
Line chart showing the yield on 10-year U.S. Treasuries in 2023, with events called out throughout the year.

Meanwhile, the S&P 500 is pretty much unchanged since the conflict began, and is still about 20% higher from its lows hit one year ago.

Digging deeper, valuations started to come under pressure over the summer as bond yields surged. And more recently, the start of Q3 earnings season seems to be most front of mind. It’s still early, but reports have so far been solid. Banks have been better-than-feared, and while tech has been mixed, there have been notable bright spots. In all, we think this quarter will mark a return to earnings growth after three straight quarters of contraction. That matters given that earnings tend to drive stock prices over the long term.

Line chart showing the S&P 500's next 12 months earnings per share (EPS) estimates in dollars.

Piecing it all together, the market seems very much aware of the conflict in Israel and Gaza, and appears to be accounting what’s known so far. That could change if we do see material escalation, but our understanding of how broader markets have behaved around similar geopolitical events suggests that the economic backdrop and business cycle are the key dynamics to monitor.

Investment considerations: Navigating uncertainty

Markets are grappling with a lot of moving pieces, from escalating tensions in the Middle East to earnings to Fedspeak. In times like these, it can be helpful to remember the power of staying invested, especially in a diversified, goals-aligned portfolio. That approach has benefitted through countless risks and periods of volatility, and we believe it can continue to do so.

We continue to think prospects for a soft landing for the U.S. economy have grown, and higher bond yields can do some work to quell the still-too-hot clip of growth and inflation. We also believe that today’s pricing offers one of the better starting points for multi-asset investors we have seen over the last decade. We think equities offer opportunity here, with more reasonable valuations, positive seasonal trends and a more constructive earnings picture offering support. And while we can’t rule out further spikes in bond yields, today’s elevated levels seem to be compensating investors for uncertainty.

There are always risks, and your J.P. Morgan advisor is here to help you navigate what it all means for your portfolio.

All market data from FactSet and Bloomberg Finance L.P., 10/20/23.

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