Playing Defense: "Risk-Off" Trading Dominates, Oil Surges After Surprise Attack On Israel

(Monday market open) After months of elevated Wall Street uncertainty, war in the Middle East added a fresh dose of geopolitical risk and threatened last week’s hard-fought but precarious market gains.

Risk-off sentiment resurfaced across global markets overnight and early Monday as crude oil surged from recent six-week lows amid worries that tension could spread to oil-producing countries. Investors gravitated toward perceived safety in gold and the U.S. dollar.

The bond market is closed for Columbus Day, so any reaction there won’t occur until Tuesday. Though bond futures do trade today, one question when the full market reopens is whether investors flock to U.S. Treasuries as a risk-off play, perhaps putting pressure on yields. That won’t be known until tomorrow.

Energy got walloped last week as crude oil sank 8% amid low U.S. demand, but crude bears a close watch in coming days for any signs that big producers get drawn into the conflict. The market appears to be adding some risk premium now in case that happens, though the areas affected now don’t produce meaningful amounts of crude.

Other sectors besides energy that might reflect the military conflict include defense contractors, airlines, and mega-caps. Defense contractors and airlines are relatively obvious areas that could be helped and hurt, respectively, by any longer, wider war. Airline shares fell and defense stocks rose in premarket trading. Volatility moved higher, implying possible larger moves in the S&P 500® Index (SPX).

Mega-caps, including Apple (NASDAQ: AAPL), Alphabet (NASDAQ: GOOGL), and Microsoft (NASDAQ: MSFT), rallied last spring during the U.S. banking turmoil, suggesting some participants rightly or wrongly see them as potential safe havens during uncertain times. Meanwhile, the handful of Wall Street stocks with exposure to Israel came under pressure early Monday.

There’s no investor playbook for this type of geopolitical event, just as there was none last year when Russia invaded Ukraine. As an investor, it’s probably best not to make sudden moves in your portfolio based on fear or emotion.

Morning rush

• The 10-year Treasury note yield (TNX) isn’t trading today due to the holiday.
• The U.S. Dollar Index ($DXY) climbed moderately to 106.43.
• Cboe Volatility Index® (VIX) futures rose sharply to 19.17.
• WTI Crude Oil (/CL) rose 4% to $85.67 per barrel.

VIX now implies potential 43-point moves in either direction daily for the SPX.

What to watch

The week ahead: Inflation data step to the plate with Wednesday’s U.S. September Producer Price Index (PPI) and Thursday’s Consumer Price Index (CPI). The order is switched this time, as usually CPI comes out before PPI.

Early estimates are for growth of 0.3% and 0.2% in headline and core monthly PPI, respectively, compared with 0.7% and 0.2% in August, according to Trading Economics. Headline and core CPI are both seen rising 0.3% month-over-month, compared with 0.6% and 0.3%, respectively, in August.

The headline CPI data will likely reflect firm energy prices, but if last week’s 8% drop in crude oil is a sign of things to come, that might ease one inflation element down the road.

“Consensus calls for continued moderation in core CPI, which would mitigate fears of an overheating economy,” says Kathy Jones, chief fixed income strategist at Schwab.

Minutes from the last Federal Open Market Committee (FOMC) meeting are due out on Wednesday afternoon and could provide more insight into how FOMC members came up with projections that hurt stocks by removing two anticipated rate cuts from next year.

Jobs report redux: While last Friday’s monster jobs report did increase chances of a rate hike before the end of the year according to futures market trading, the overall impact might be less sinister than people initially thought. 

As we noted here Friday, September jobs growth of 336,000 arguably wasn’t on anyone’s radar, but mild wage increases that didn’t spark inflation fears removed some of the sting. That could be why just hours after the report, chances of a Federal Reserve rate hike before year-end were near 50%, well below the 65% threshold that traditionally signals a Fed move. Of course, investors should continue to monitor the futures market for changes. There’s also still a strong probability built in of the Fed cutting rates by the middle of next year.

On a three-month annualized basis, wage growth has slowed to 3.3%, says Kathy Jones. “Despite the economy adding jobs, there wasn’t a significant rise in wages to draw in workers,” she says. Also, she adds, falling commodity prices and soft global data are mitigating some concerns, and the market has priced in a lot of bearish worries.

The other mitigating factor—and perhaps one reason stocks rebounded in the hours after the data—belongs in the “good news is good news” realm. Meaning solid jobs growth is often the sign of a healthy economy, and economists mainly expect very firm Q3 growth.

That might soften in Q4 due to issues like the resumption of student loan payments, the dwindling of savings as pandemic savings get spent, the lag impact of higher Treasury yields, and a possible government shutdown. But for now, the jobs report is one more proof point that the economy continues to chug along even though some metrics are slowing (see more below).

Stocks in spotlight

The Q3 earnings season begins this week, highlighted by a host of big bank earnings on Friday. Other expected earnings include PepsiCo PEP, Walgreens Boots Alliance WBA, Delta Airlines DAL, and Domino’s Pizza DPZ. The big banks reporting Friday are JP Morgan Chase JPM, Citigroup C, and Wells Fargo WFC.

“Earnings season will be key for corporate outlook, with likely notable attention on not just traditional metrics like beat rate and the percentage by which companies beat, but also the differential between top- and bottom-line growth and between nominal and real growth,” says Liz Ann Sonders, Schwab’s chief investment strategist.

The reference to “nominal versus real” means adjusting companies’ results from the impact of inflation. A big revenue jump based on higher prices may be difficult to maintain, especially amid signs of customers pushing back on price hikes. Companies that grow revenue by raising prices or cutting costs may not get as much credence from investors looking for organic growth.

Stocks with exposure to Israel came under pressure in premarket trading today. Some of these include Teva TEVA, Nice NICE, Elbit ESLT, Check Point Software CHKP and Mobileye Global MBLY. The parent company of Mobileye is U.S. chipmaker Intel INTC.

Glancing back to Friday, before the Middle East turmoil began, U.S. stocks broke a four-week losing streak as stocks rebounded from early losses. September’s Nonfarm Payrolls report showed massive jobs growth of 336,000 but wage gains looked subdued. U.S. Treasury note yields retreated after a dramatic early rally to new 16-year highs.

Information technology and communication services, which sagged in Q3 after starting the year with a bang, led the sector scorecard last week. Consumer staples and utilities, traditionally defensive areas, were near the back of the pack.

Eye on the Fed

Early today, the probability that the FOMC will raise its benchmark funds rate from its current 5.25% to 5.50% target range following its October 31–November 1 meeting was 18.5%, according to the CME FedWatch Tool. Odds that rates could be a quarter-point higher coming out of the December 12–13 meeting were about 35%. A number of Fed speakers are on the calendar this week.

CHART OF THE DAY: WILD FRIDAY. The impact of the shockingly strong September jobs report can be seen in this intraday chart of the S&P 500 Index (SPX-candlesticks) and the 10-year Treasury note yield (TNX-purple line). The chart includes Thursday and Friday’s sessions. The steep climb in yields and drop in stocks occurred first thing Friday when the report hit, and then stocks spent the rest of the day recovering while yields dropped sharply and then leveling out. Data sources: S&P Dow Jones Indices, Cboe. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

If it ain’t broke…: One takeaway from Friday’s Nonfarm Payrolls report is that U.S. jobs growth is booming—though watch for possible downward revisions going forward—without a massive rise in wages. This, along with the fact that the 10-year Treasury note yield is knocking on the door of 5%, means there’s potentially less work for the Fed to do. The Fed won’t try to stop jobs growth for the sake of slowing jobs growth—so long as it doesn’t translate into inflation. And those high yields that sent stocks to four straight weeks of losses in September mean the market itself is doing some of the Fed’s job for it. Naturally, this week’s inflation data could change the story somewhat if it looks hotter than expected. However, you need to look at the preponderance of evidence, not a single point in time, and many economic lights are flashing yellow over the last few months rather than green.

Good old days: While you may hear that the economy did fine decades ago with mortgage rates of 8% and 10-year yields of 5% or higher, the sharp uptick from last spring’s 10-year yield low of 3.29% to today’s level near 4.75% is what likely matters more than the level itself. The dramatic and unrelenting rally is unusual to say the least, and makes it very difficult for investors, the Fed, and businesses to plan. The rapid rise in yields injects uncertainty about everything from future consumer sentiment to business spending, and it’s a major reason for recent stock market weakness. Wall Street tends to flinch from uncertainty. High yields might have more impact on companies and consumers in Q4 if they persist, though that depends to some extent on how much credit spreads widen.

Japan correspondence: The Bank of Japan (BoJ) announced more bond purchases last week, something it may be doing to keep yields from rising too fast and squeezing economic growth. A rally in the yen then triggered speculation that Japan was intervening to prop up its currency as it did a year ago, which could pressure the dollar and hurt overseas companies buying products from Japan—though it would help Japanese exporters. There’s no confirmation yet from Japanese authorities, Bloomberg reported, and the yen slumped again. Also, there’s no evidence of Japanese investors being to blame for rising global Treasury yields. “Despite some concerns that we’re seeing the unwinding of the carry trade of using low borrowing costs in Japan to buy overseas bonds, Japanese investors have been net buyers of foreign assets both this year and since the cap on the BoJ’s yield curve control was raised in July,” says Michelle Gibley, director of international research at Schwab.  

Calendar

Oct. 10: August Wholesale Inventories and expected earnings from PepsiCo (PEP).

Oct. 11: September PPI and Core PPI.

Oct. 12: September CPI and Core CPI, and expected earnings from Delta (DAL), Domino’s (DPZ) and Walgreens Boots Alliance (WBA).

Oct. 13: Earnings expected from JP Morgan Chase (JPM), Citigroup (C), Wells Fargo (WFC), United Health (UNH), and BlackRock (BLK), and University of Michigan Preliminary October Consumer Sentiment.

Oct. 16: October Empire State Manufacturing 

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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TD Ameritrade® commentary for educational purposes only. Member SIPC.

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