Bond yields have surged since the start of this month, and that has dictated the direction of the global equity markets, as well as triggering a pullback in stock prices. With strong US economic data comes the fear that the Fed’s next interest rate move might be upwards, in which case even higher bond yields will follow. Last week’s jobs report for September confirmed that the labour market is showing no real signs of weakening. Indeed, payroll growth far exceeded expectations and has picked up the pace over the last couple of months. The result is higher rates and retreating stocks. There was, however, further moderation in wage growth: this could be interpreted as good news for inflation.
While spring and early summer brought some relief to investors in the stock markets, a new phase – one during which equities are almost entirely reacting to interest rate moves – has led to weakness and uncertainty. The mid-year rally was mostly powered by our increasing belief that we had entered a “Goldilocks” economy that was running neither too hot nor too cold. But we are now in the grips of anxiety over the effects of higher-for-longer interest rates combined with a fall in economic growth. Indeed, as we enter the winter months, we are faced with stubborn inflation, higher rates, the ever-present prospect of recession, war in Europe… and now burgeoning hostilities in the Middle East.
There is no denying that market pullbacks are uncomfortable. But for what it's worth, October is renowned for “copper-bottoming” market floors. Indeed, of the last eight bear-market floors over the past 50 years, half of them have been in October (1974, 1990, 2002, 2022). As a side note, the floor created by Black Monday back in October 1987 lasted a little longer – the new bull market did not emerge until two months later in December... just after the Dow Jones Industrial Average Index plummeted 22.6%.
The corollary of the above is that October is also well-known for being the best month for new stock market rallies to begin: this week sees the first-year anniversary of the bear-market low recorded on 12 October 2022. Of course, currently, there is an abundance of unknowns and negative factors at play. But history has shown that one-year old bull markets tend to be able to withstand a few bumps in the road along the way.
That said, events such as the current Gaza-Israel conflict will create a further set of stresses and uncertainties over and above those that already characterise the global landscape (stubborn inflation and high-interest rates).
Oil prices have already jumped on concerns that the situation in Israel and Gaza could disrupt output from the Middle East. While this is likely to be temporary, much will depend on the length of conflict.
There are clear parallels to be drawn between current developments and the world's first oil crisis 50 years ago back in October 1973. However, the global economy is unlikely to suffer from an Arab embargo in quite the same way as it did then – which saw crude oil prices rising by nearly 300%. But it would be a mistake to downplay the chances of oil prices remaining higher for longer – particularly with OPEC+ countries cutting their oil quotas.
The situation is stable for now. For the oil market, everything depends on how Israel responds to Hamas… and to Iran, which has a great deal of influence over the Palestinian political and militant organisation and provides a significant chunk of its funding.
A very different set of circumstances characterised the October 1973 crisis, with Arab countries attacking Israel in unison. Currently, Egypt, Jordan, Syria, Saudi Arabia and the rest of the Arab world are watching from the sidelines and not getting involved. Furthermore, in October 1973, oil demand was surging and the world had exhausted its spare production capacity. Today, consumption has moderated and is likely to slow further as the energy transition gets underway.
Another factor in the overall equation is that Saudi Arabia and the United Arab Emirates have significant spare capacity, and that serves to curb prices. Indeed, OPEC is not trying to boost prices aggressively: it is quite content for prices to hover between US$85 and US$100 a barrel. Prior to the October 1973 embargo, OPEC countries unilaterally hiked the official petroleum prices by some 70%. The embargo may be what sticks in people’s minds about the crisis… but the price hike was just as critical.
Uncertainty is the byproduct of any confrontation. There is still a chance that the oil markets will end up being impacted for the remainder of 2023 and part of next year. Immediate repercussions will be felt if Israel concludes that Hamas acted on instructions from Teheran. That would push oil prices up significantly. In 2019, Iran demonstrated, through Yemeni proxies, that it is able to knock down a significant chunk of Saudi oil production capacity. So it could do that again in retaliation if it finds itself under attack by Israel or the US.
Currently, any one of a number of scenarios is possible, and any escalation could easily push oil prices up to US$100 a barrel and beyond. It goes without saying that Moscow will be monitoring events closely – Putin stands to benefit from any Middle East crisis. The US enforcing sanctions against Iran would create an opening for Russia’s own sanctioned barrels, and it could both win market share and achieve higher prices.
Without immediate diplomacy, oil prices could surge, affecting inflation and shaping central bankers’ monetary policy. The US, for example, is sure to tap into its Strategic Petroleum Reserves to limit any impact on its gasoline prices – even though inventories are at their lowest in 40 years. Things are not quite as bad as they were in 1973, but they could turn ugly if diplomacy fails.
There are no guarantees that the current mood in the stock market will improve any time soon as events continue to unfold in the Middle East. But it is always important to bear in mind that volatility creates a compelling buying opportunity – in both stocks and bonds. A combination of fundamentals – the general state of the economy, corporate earnings and interest rates – will be what determines the direction of the markets over the coming months... not simply what month of the year we are in. Confrontation and armed conflict are inevitably a source of volatility and weakness (at least for a while). But, tragic though the current situation may be in so many ways, the war between Hamas and Israel is not in itself a reason to sell stocks.
