Navigating geopolitical uncertainty – Short-term risks vs. long-term opportunities

DEWITT, Mich. - Oct. 17, 2023 - PRLog -- Key takeaways:

• The events in the Middle East are a human tragedy that should not be dismissed, but markets have a long history of overcoming geopolitical shocks.
• The silver lining from the recent surge in Treasury yields is that it may reduce the need for more rate hikes. Last week, the flight-to-safety and a gradual shift in the Fed's messaging helped bonds rebound.
• The bear market in bonds is likely reaching its final stage as interest rates approach a cyclical peak. But for a strong rally to materialize, Fed rate cuts will be required.
• The widening divergence in equity performance creates some emerging opportunities. Valuations for the lagging segments of the equity market, which include small-caps, bond-proxies like high-quality dividend stocks, defensive sectors, and value-style investments, are favorable.
• There are reasons to stay optimistic as we wrap up 2023. We recommend investors double down on diversification and look for opportunities in high-quality investments that have fallen out of favor.

Since stocks bottomed one year ago, elevated inflation, rising rates, and political dysfunction have been ongoing concerns as markets have climbed the proverbial wall of worry. Last week, the terrible events unfolding in Israel added another worry to the mix, with investors trying to account for military conflict in the financial outlook. First and foremost, the attack is a human tragedy for all affected and should not be dismissed. From a market perspective, the focus is on implications for oil prices, interest rates and the dollar, as they have a more direct link to the fundamental drivers of performance.

We'd offer the following takeaways on the potential investment consequences from the heightened geopolitical risk. We also highlight some emerging opportunities created by the increasingly split nature of the market's advance over the past 12 months.

Markets have a long history of overcoming geopolitical shocks

• Like many of the past geopolitical crises, the attacks in Israel triggered an initial flight-to-safety move in the markets, with government bonds, the U.S. dollar, and gold rallying. Oil jumped more than 4% last Monday on fears that supply could be disrupted, but it gave back some of its gains in the subsequent days¹.
• The situation remains fluid, and the potential of a prolonged war could destabilize the Middle East, but so far there has been no impact to global oil supply. There are still questions about Iran's involvement, but unless the conflict spreads, it appears that the supply-and-demand dynamics for oil won't change materially. At the same time, the flight to safety in Treasury bonds has eased some of the valuation pressures on equities from rising rates, which helps explain why U.S. equity markets rose modestly last week.

Source: 1. Bloomberg