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I had a flurry of messages like this last weekend:
Most everyone - except a few students at Harvard - were appalled by the actions Hamas terrorists took against Israeli civilians last weekend. While it’s hard to focus on markets when hundreds of people are laying dead and injured, it’s part of the job description to stay unemotional in times like these.
And that’s exactly what we’ll do today, as it’s important you understand how markets react during times of war.
From a Bird’s Eye View
It should be obvious that all wars are not created equal.
A nuclear conflict between China and the US would have far graver implications than a civil war in Sudan. And while the current conflict between Israel and Hamas is horrible in its loss of life, it is currently a relatively small conflict.
That could change if larger players like Saudi Arabia, Iran, and others come into the mix. But for now, the risk of broader contagion appears contained.
But when looking from a bird’s eye view, major geopolitical events have historically had a “muted” impact on markets. For instance, going back to 1940 the average 12-month S&P 500 return after the onset of a geopolitical conflict is +2.1%:
And that makes sense when you remember when drives stock prices.
Earnings Implications are Key
I do not want to come across as crass or uncaring.
But when approaching the market implications of war from an objective standpoint, you should be asking yourself one thing: how does this conflict affect S&P 500 earnings?
As we’ve discussed before, stocks are priced based on their future earnings.
Notice I’m saying “future” earnings growth. Because when it comes to investing, you shouldn’t care about what a company did in the past. It’s all about future earnings growth.
And when it comes to war, the question you need to answer is if any disruptions will affect these future earnings.
Unless we see an escalation of the current conflict, I don’t see the current Israeli-Hamas conflict impacting broader markets in a material way. The S&P 500’s muted reaction this week adds credence to that notion.
But there are certain sectors that may be more “war-sensitive” than others.
Three “War Sensitive” Trades to Watch
Conflicts in the Middle East have rarely had an impact on US markets.
But there are certain markets - particularly commodity markets - that are directly affected.
For instance, the Middle East is a major oil-producing region. When conflicts escalate or there are concerns about disruptions in oil supplies from the region, it can lead to increased oil prices.
This is a key reason we saw some oil stocks rise last week:
Second is “safe haven” assets. Precious metals like gold, relatively “safe” currencies like the US dollar, and US government bonds typically see inflows during times of war. We saw this unfold last week with a major move in spot gold prices:
Lastly, defense companies can see increases in their stock prices during times of conflict under the assumption governments increase defense spending during times of conflict. Companies that provide military equipment and technology often benefit from these situations.
This is a key reason we saw stocks like General Dynamics (GD), Lockheed Martin (LMT), and Palantir Technologies (PLTR) surge earlier this week:
And while it’s smart to keep these “war stocks” on your radar, I expect a rally regardless of what happens in the Middle East soon.
The #1 Reason to Stay Optimistic
As we discussed last week, one of the main headwinds for markets has been surging US government bond yields.
But it looks like the bond bear market may be coming to a close. As I mentioned, during times of conflict investors typically rush to the safety of US government bonds.
Considering the 10-year is currently yield 5.5% risk-free, I expect many global investors to flock to bonds in the near-term, thus putting a “cap” on yields.
Not only that, “sentiment” - which we discuss often in this newsletter - had reached a fever pitch in the bond market. News articles mentioning that word “relentless” and “bonds” have spiked to the 2nd-highest in 8+ years. It was only higher once, which was almost exactly a year ago.
You even had the mainstream media claiming yields were going as high as 13%:
The media is trying to get you to “click” on things. When a trend is reaching its peak, they’ll do and say anything to get you to click on their B.S. doom-and-gloom articles.
But what I’ve heard nobody mention is the presidential election cycle, which the current bull run has been following to a T. And if it continues to follow this long-term trend, we’re in for a massive year-end rally…
…and I don’t plan to miss it.
Stay safe out there,
Robert