Markets seem well aware of the risks, but history tells us that economic activity and the business cycle can matter more.
Our Top Market Takeaways for October 23, 2023.
Market update
Making sense of the market moves
It’s been just over two weeks since news broke of the Israel-Hamas conflict, and the fallout continues.
The human toll has been devastating. And as tensions continued over the weekend, many appear 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 to today, Israel’s currency – the shekel – has weakened over 5% versus the dollar, and prices for both oil and safe haven gold have spiked almost 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.
These line charts show the price of Brent crude oil on the left and Gold on the right,
The left chart showing Brent crude oil prices starts at $73 per barrel at the start of June, and hovers around to $75 level for the first month. Throughout July and the start of August, oil prices surge from below $75 to $88 on August 8. From there, we see a slight pullback to $84 at the end of August before rebounding sharply to a series high of $97 on September 27. Prices then sell off sharply to $85 on the day that the Israel-Hamas War began. Since then, oil has snapped back higher to today’s level at $93.
The right chart showing gold prices starts at $1980 in June and initially falls over the first month to $1907 by June 28. Gold prices then fluctuate between the $1900 and $1950 level over the next few months, before sharply selling off at the end of September and start of October to a series low of $1820 at the time when the Israel-Hamas war began. Since then, there has been a sharp rebound to today’s level at $1980, which marks a series high.
When it comes to broader bond and stock markets, different drivers seem more at play.
10-year U.S. Treasury bond yields surged further over the last week, even touching 5% on Monday morning, and yields in the UK and Eurozone likewise rose. 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. Consumers are 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 central banks 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 being 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 20 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 toward 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.
The chart describes the yield on 10-year U.S. Treasuries in 2023, with events called out throughout the year.
The line started at 3.87% on January 2, 2023.
The line trends downward, and at the event “February FOMC meeting” the arrow points to a yield of about 3.41% on February 1, 2023.
The line trends upward to the next event “U.S. regional banking crisis” and on March 8, 2023 the yield was 3.99%.
The line trends downward to the next event “May FOMC meeting kickstarts “higher for longer” chatter” and on May 1, 2023 the yield was 3.57%.
The line trends upward to the next event “Bank of Japan loosens its yield curve control policy” and on July 27, 2023 the yield was 3.99%.
The line moves downward to the next event “Fitch downgrades U.S. government credit rating” and on July 31, 2023 the yield was 3.96.
The line trends upward to the next event “U.S. Treasury ramps up issuance” and on August 9, 2023 the yield was 4.00%.
The line trends upward to the next event “September FOMC meeting” and on September 22, 2023 the yield was 4.43%.
The line finishes on October 20, 2023, at 4.91%.
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 so far have 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.
The chart describes the S&P 500 earnings per share (EPS) estimates since Jan 2022 in $. The line started at $217 on December 30, 2021. It went all the way up and peaked at $236on June 23, 2022. Then it went all the way down and troughed at $223 on February 23, 2023. Then it went back up again and reached $238 on October 20, 2023.
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 team is here to help you navigate what it all means for your portfolio.
All market and economic data as of October 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
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