10-8-24: Beware the Market’s “Geopolitical Overhang” in October

by Ivan Martchev

October 8, 2024

The stock market appears to be ignoring negative seasonal patterns in both September and early October and is trying to reach again for fresh all-time highs. Septembers tend to be terrible, on average, over the last 100 years but 2024 was definitely not bad, registering an all-time high in the S&P 500. Octobers are not so terrible over the last century, but they tend to be worse in presidential election years compared to other Octobers. Still, seasonality is not a guarantee, and if it were not for what I call “the geopolitical overhang” that we have at present, we very well could have made another all-time high last week.

I think the fate of this October will be decided by Iran and Israel – whether the situation becomes a tit-for-tat cycle of acrimonious recriminations, or if it is just a one-off exchange of blows like last time. The U.S. administration definitely prefers no strikes on Iranian oil assets, as President Biden said last week in a press briefing, since he apparently doesn’t want to deal with a huge oil price spike just before the election.

I am sure most market participants would prefer the Iranian situation not to spiral out of control, and it would be smart of the Israelis to focus on Hezbollah and only deal with Iran when the Lebanese incursion is finished, so if there is no continued exchange of rocket fire between Israel and Iran in October, stocks would likely celebrate, despite the risk that escalation is coming sooner or later. The fact that the VIX was down on Friday and that stocks rallied into the close tells me that investors hope the escalation is delayed.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The problem is the price of oil is held hostage to the Strait of Hormuz, where about 40% of global oil must traverse. That traffic can be stopped at any time, if Iran chose to use the oil price as a weapon. Strikes on Iranian oil assets and a decrease of flow of oil through the Strait of Hormuz could push the oil price above $100 per barrel. How far above $100 it goes would be dependent on how much global oil flow is affected. No one can be sure ahead of time how fast or how bad it can get in such a scenario.

Despite this negative geopolitical backdrop, we will likely see some positive inflation (CPI release) news on Thursday, reinforcing the case for more rate cuts. Inflation has been running below the Fed’s target, if one were to ignore owner’s equivalent rent, which is a concept hard to measure as an inflation metric. The Europeans don’t include such a component in their inflation calculations, so when you compare inflation rates across countries, you have to be remember that you are looking at an apples-and-oranges situation.

I know prices are high, and consumers remember what they paid for many things in 2020 vs. 2024, but inflation is a rate of change, not an absolute level. On that basis, the Fed is exactly where it wants to be.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The Hang Seng (Hong Kong market index) was up 8.25% last week, further extending its gains over the prior week, when it was up in the teens, all due to China’s monetary stimulus. I think this index can make further gains as well as the more diversified MSCI Emerging Market Index, especially if the geopolitical overhang from the Israeli situation diminishes. Emerging markets have been lagging for a long time, and if the Chinese stimulus package works, the impact on this whole asset class can be quite substantial.