It’s been a volatile stretch for US equities as Wall Street tries to wrap its arms around the war in Iran. But with the fighting now in its third week, investors are becoming more sanguine about the stock market as signs emerge that the worst may be over.
Of course, concerns remain. Surging oil prices driven by the shutdown of the Strait of Hormuz threaten to spur inflation, reducing the odds of an interest-rate cut from the Federal Reserve and raising the chances of an economic slowdown or a recession. Supply chains for various products, from metals and materials to food and pharmaceuticals, are at risk. And then there are the worries about artificial intelligence disruption and private credit exposure that were weighing on sentiment before the war began.
But even as the hostilities show little sign of letting up, investing pros are seemingly learning to roll with the geopolitical uncertainty. The S&P 500 Index is up 1.3% this week, its best two-day performance since the US and Israel began their bombing campaign, and is down just 3.8% from its all-time high in January. Meanwhile, options traders have been unwinding some of their bearish bets. And a recent decline in investors’ equity exposure may be a sign that the market is finding a floor.
“The question is: Why have they not been spooked by it?” said Sam Stovall, chief investment strategist at CFRA, adding that the losses are below the threshold for a pullback. “I think, in many ways, investors are encouraged by the resilience of the market and likely points to a continued improvement in earnings growth estimates as the reason for the underlying support.”
The cost of using options to protect against a 5% decline in the State Street SPDR S&P 500 ETF, better known by its ticker SPY, relative to a similar rally has been subsiding after hitting the highest level in more than a year earlier this month.
A relative sense of calm is apparent in the Cboe Volatility Index, or VIX, which traded as high as 35 on March 9, a sign of rising market distress, but has since retreated, closing Tuesday at around 22. Subdued demand for options betting on a jump in the VIX coupled with outflows from long VIX exchange-traded products, point to a lack of panic by investors, according to derivatives strategists at Barclays.
Declines in the S&P 500 have been “comparatively modest” despite the volatility, said Noah Weisberger, chief strategist at BCA Research. Steeper losses are still possible, but the amount of time it’s taken to get to just a 5% pullback could be a good sign. Futures on the S&P 500 Index were up 0.5% at 7:13 a.m. in New York.
Should the index suffer a 5% drop from its recent high by the end of the week it will have taken more than 47 days. Since World War II, the S&P 500 has never fallen into a bear market when it has taken more than 40 days to decline 5%, CFRA data show.
Time may also be be playing a role in the improving market sentiment.
Heightened levels of geopolitical uncertainty are “nothing new” for Wall Street, with the only difference being a shift in the “epicenter,” according to Sameer Samana, head of global equities and real assets at Wells Fargo Investment Institute. Since acute selloffs are historically short-lived unless a significant portion of the global economy is teetering, investors are “better off diversifying than trying to run away from individual, new conflicts,” he said.
As for when the S&P 500 will see record highs again, the mere hint of a potential resolution to the fighting could spark it, CFRA’s Stovall said.
“If we do find that there are at least negotiations taking place, which obviously could lead to the end of hostilities and would bring oil prices down, I think that would be a trigger,” he said. “Even the prospect of talking about it, I think it would go a long way toward helping the market recover and attempt to set a new all-time high.”
Samana is looking for something more specific as an initial catalyst, namely the reopening of the Strait of Hormuz. If that happens quickly then the market will be looking for the next sign. But if it drags on, that could weigh on investors.
“If the Strait opens back up we’re probably rangebound until we get more information on the other uncertainties,” said Samana. “If the Strait closure drags on for months, then the possibility of much higher oil prices could lead the S&P to break key support at the 200-day moving average, in which case you may see retail capitulate.”
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