Oct 22, 2023 4 min read

Market Call: 'Dangerous Times'

Strategy I: Middle East's Existential Crisis. Jamie Dimon is probably right. On October 13, the CEO of JPMorgan Chase sounded the alarm on the global effects of the wars in the Middle East and Ukraine. “This may be the most dangerous time the world has seen in decades,” he said in a statement accompanying the bank’s quarterly earnings. He warned of “far-reaching impacts on energy and food markets, global trade and geopolitical relationships.” 

The war between Israel and Hamas might have escalated into a regional one on Thursday. That’s when a US warship heading south in the Suez Canal over a period of nine hours intercepted and destroyed four cruise missiles and 15 drones heading toward Israel from Yemen. The missiles were fired by Iranian-backed Houthi forces in Yemen and were launched “potentially towards targets in Israel,” according to the Pentagon’s press secretary. In response, the US fired sea-launched cruise missiles at Houthi radar facilities in Yemen, according to a CNN report

This development contributed to the 1.3% selloff in the S&P 500 on Friday. So did the increase in the 10-year Treasury bond yield to 4.997% Thursday evening (chart). But the yield was back down to 4.928% at Friday’s close. The decline in the yield undoubtedly reflected profit taking by short-sellers and a mini-flight to safety in reaction to the latest unsettling developments in the Middle East. 

On October 7, when the war started, I wrote in our Morning Briefing the following: “Geopolitical crises in the Middle East have usually caused oil prices to rise and stock prices to fall. More often than not, they've also tended to be buying opportunities in the stock market. Much will depend on whether the crisis turns out to be another short-term flare-up or something much bigger like a war between Israel and Iran.” 

In the October 10 Morning Briefing, we raised our subjective odds of a broad-based US recession from 25% to 30% because of the war: “This one isn’t likely to lead to a quick ceasefire between Israel and Hamas, as occurred in the past, because it is in fact a war between Israel and Iran. For Israel, it is existential. This time, Israel’s goal is to wipe out Hamas, which is Iran’s surrogate in Gaza. The war is also existential for Iran’s mullahs, who need it to distract the population from discontent over their authoritarian regime by moving forward on their machinations to wipe out Israel.” And, of course, the war is now existential for Hamas since Israel has vowed to destroy the terrorist organization. 

Under the circumstances, the odds of an escalation of the hostilities are increasing, while those of a ceasefire anytime soon are falling. As a result, we’re raising our odds of a recession again, to 35%. A regional war has become more likely now that the US has gotten directly involved by shooting down missiles launched by Iran’s surrogates in the region and destroying their military assets on the ground. 

There could still be a yearend stock market rally, but there is likely to be more downside in the next few weeks while the regional combatants and also the US Navy are targeting each other. The S&P 500 index fell back to its 200-day moving average on Friday and looks set to breach it if the news out of the Middle East continues to worsen, as we now expect, even if the bond yield declines on the same news (chart). 

The question is whether this war will escalate to the point where American and Israeli policymakers conclude that now is the time to destroy Iran’s nuclear facilities. We are sure the question will be raised. We don’t know what the answer will be or even whether such an escalation is militarily feasible. 

We are keeping an eye on Taiwan too, as is China. A month ago, a record number of Chinese fighter planes—103 of them—flew around Taiwan in just one day. On Wednesday, Taiwan reported that 10 Chinese military aircraft and four navy ships buzzed close to the island nation. China’s government might view this as an opportune time to invade Taiwan now that the US is stretched militarily by supporting both Ukraine and Israel. 

As Jamie Dimon said, “This may be the most dangerous time the world has seen in decades.” There isn’t likely to be much upside for the stock market until the geopolitical risks turn less dangerous, particularly in the Middle East. We certainly aren’t sure how long that will take, but we think these risks will linger for a few weeks at least. 

As noted above, geopolitical crises have often turned out to be buying opportunities. At first, the stock market didn’t respond adversely to the war in the Middle East. It may be starting to do so now. If so, then this too should result in buying opportunities, particularly in Energy, Financials, and Information Technology. Of course, defense stocks should also benefit from these dangerous times. 

Strategy II: Feshbach's Call. Our near-term cautiousness is in sync with the views of our friend Joe Feshbach. Here are his latest thoughts on the stock market from a trading perspective: 

“I remain cautious on the stock market, as the internal dynamics--especially as measured by breadth statistics--remain awful (chart). I have been highlighting the Nasdaq in particular, where the cumulative A/D line has been constantly making new lows. Also on the surprisingly disappointing side is how the put/call ratio has responded to this decline.

"One would have thought that with horrible breadth accompanied by terrible news, put buying would skyrocket. It has not. Yes, the numbers have picked up, but we are nowhere near levels that would indicate fear and a possible low. I'm very curious to see how the ratio will react if the S&P 500 breaks its prior intra-day low of 4216 this week.” Thanks Joe!

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