Equities falter as tensions rise in Middle East

US stocks keep going from strength to strength in a bull market that has now been in force for almost two full years. After minor blips in the form of sub-10% drawdowns in July and early September, the S&P 500 and Nasdaq 100 recently recorded new all-time highs once again this year to reach $5,762 and $20,115, respectively. A modest correction soon followed amid escalating tensions in the Middle East, yet both key indices are still up almost 5% on the month and look to continue their positive movement despite the traditionally tricky pre-holiday period. 

The macroeconomic situation remains largely favourable to risk-on assets like equities, and the Federal Reserve's recent bumper 50 bps rate cut and new dovish stance will certainly help to buoy markets. However, the threat of wider regional war and the associated rise in oil prices continue to threaten equities' atypically long bull cycle. In this article, we will analyse the key factors over the coming months as we try to gauge their potential impact on stock prices.

Fundamentally speaking

If we look at the general macroeconomic picture in the US, it is largely positive when it comes to the labour market, consumer price index, and, of course, central bank monetary policy. Indeed, the US Labour Department's Job Openings and Labour Turnover Survey (JOLTS report), which was released Tuesday (01/10), showed new job openings up 329,000 to 8.04 million in August as layoffs also declined by 105,000. This strong data, in combination with an unchanged Manufacturing PMI, has suggested that another rate cut could be forthcoming as early as November. The original 50 bps cut last month is widely believed to have helped reverse the correction we saw beginning in early September, but fears that the new wave of growth generated could run out of steam before the Santa Rally in December will surely be assuaged by another rate reduction from the Fed. Whether this will be possible will surely be dictated, at least in some part, by the Consumer Price Index numbers later this month. The revelation of 2.5% in August probably influenced the US regulator's decision to slash its key interest rate in September. However, the risk of a spike in price pressure following such a dramatic move remains. Powell will certainly be watching for September's CPI numbers before making another equities-boosting rate cut in the coming months.

Nothing's certain in this world

Despite the overwhelmingly positive trend on all three major US indices, the elephant in the room remains the spiralling geopolitical instability both in Europe and now the Middle East. After a series of tit-for-tat attacks, there has now been a bona fide invasion of Lebanon for which Iran has retaliated with large-scale missile attacks on Israeli military targets. This is a clear escalation that warrants concern, as a regional war has the potential to increase oil prices significantly and indirectly impact the productivity of US businesses. As Globalt Investments senior portfolio manager Keith Buchannan put it, "The fear of contagion is always destabilising. Aside from, of course, the paramount impact on lives, the markets take a direct hit when there are forces that are almost promising some level of destabilisation." And while this is surely true, we have to remember that the entire region has been on a knife edge since October last year, with numerous flash points threatening huge destabilisation. Through it all, however, the markets continued to rise unperturbed – and there's no reason this can't continue to happen. Without being too cynical, it's also important to note that the military-industrial complex and big oil represent a huge portion of US equities, and, for many of these companies, a war would actually be good for business. While we clearly wouldn't want such an eventuality, the losses in other areas could easily be balanced out by the bumper profits in these industries.

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