What happened in the markets - 9-13 Oct 2023

Introduction

This week's stock performance was a bit of a rollercoaster ride, with a mix of highs and lows. Investors were on their toes due to concerns about inflation ticking up, the escalating conflict in the Middle East, and a few Fed officials hinting at uncertainties about the future direction of interest rates. This cocktail of factors led to a dip in bond yields. But hey, it's not all doom and gloom! Next week, we've got some key data releases on the horizon that could shed some light on the current economic climate. Retail sales data is set to drop, which should give us a clearer picture of consumers' spending power. We've also got some jobs and claims data coming up, which could indicate whether the strength and resilience of the labor market are starting to wane. Both these sets of data could be crucial in helping investors gauge the risk of a potential recession. So, buckle up, folks! It's going to be an interesting ride.

Key Takeaways

The ongoing crisis in the Middle East is a heartbreaking human tragedy that we cannot ignore. However, history has shown us that markets have a remarkable ability to weather geopolitical shocks.
In a surprising twist, the recent surge in Treasury yields could potentially lessen the need for additional rate hikes. Over the past week, a combination of a flight-to-safety and a gradual shift in the Fed's messaging has given bonds a much-needed boost.
The bear market in bonds seems to be nearing its end as interest rates approach a cyclical peak. However, for a robust rally to take place, we'll need to see some rate cuts from the Fed.
Interestingly, the growing divergence in equity performance is opening up some new opportunities. The lagging segments of the equity market, which include small-caps, bond-proxies like high-quality dividend stocks, defensive sectors, and value-style investments, are now looking quite attractive in terms of valuations.

Geopolitics: Eruption in the Middle East

Financial markets are currently in a state of flux, with a noticeable shift towards a risk-off mode. This is evident in the rising values of oil, gold, and the USD, while safe-haven government bonds may see a pause in yield increases. The potential escalation of conflict towards Lebanon or Iran is a major concern that's causing this shift. The current geopolitical situation is causing a ripple effect across global markets. However, it's important to remember that from a commodity perspective, geopolitical events are often temporary noise rather than a lasting and impactful fundamental force. Analysts are keeping a close eye on the situation. They believe that, for now, events will most likely follow the usual geopolitical playbook. This means any escalation could prolong the duration and increase the intensity of the market shock. But the impact of geopolitics isn't just confined to the Middle East. Chinese stocks, for instance, are also being influenced by global factors such as US rates and the fluid geopolitical situation.

The current geopolitical situation is fluid, with the potential for a prolonged conflict that could destabilize the Middle East. However, as of now, there has been no significant impact on the global oil supply. Questions about Iran's involvement remain, but unless the conflict expands, it seems that the supply-demand dynamics for oil won't undergo any significant changes. Interestingly, the flight to safety in Treasury bonds has eased some of the valuation pressures on equities from rising rates. This could be why U.S. equity markets experienced a modest rise last week. The evolution of the conflict and its implications is a known unknown for investors - a known event with unknowable risks. Yet, history suggests that geopolitical risks and the associated shock in confidence tend to be short-lived. Markets usually gravitate towards more sustainable drivers for returns. Looking back at 10 prominent historical episodes of military conflicts/attacks, we see a pattern. The immediate reaction is usually a decline in stocks on the day of the event, and performance tends to be mixed over the following month. This is because investors naturally shy away from uncertainty. However, the impact on returns usually proves temporary. In most cases, equities were higher six months and one year later. This suggests that while geopolitical events can cause short-term market volatility, they rarely alter the course of markets in the long run.

S&P 500 Performance Following Major Geopolitical Events