*Editor’s Note: This blog was written prior to the U.S. military operation executed in Iran over the weekend.
Just a couple of weeks ago, the S&P 500* was within 98 points of a new all-time high. But that climb was unfortunately interrupted by military escalation in the Middle East.
Obviously, human life is the most important factor. Military events are unfortunate and destructive. For any winners in war, a wake of destruction afterwards often confronts many.
And at Cornerstone, our job is to analyze markets. If wars didn’t exist, frankly, our job would be easier. But they do exist, and from a pure investment standpoint, we must analyze markets, even in the face of war.
The unpredictability of military events means we don't know how long they will last. We also don’t know how war will affect economics, like the price of oil. So, today we want to parse through the noise with some useful indicators and historical data analysis.
This much is certain: the longer the conflict lasts, the harder it will be to predict how it ends. But if tensions recede, this could end up as a blip on the radar, like many previous military events.
The price of oil will say much about how the conflict is developing. A declining oil price would be an early indicator that things are winding down.
It would be quite hopeful to think this conflict could wrap up quicker than the popular narrative would lead you to believe. But in Israel’s case, one often overlooked indication of how long military conflicts last is the national airline carrier El Al.
It’s been helpful because during significant military events, El Al transitions from a commercial enterprise to a military support entity. As of now, Israel cancelled flights to most destinations until June 23.
That’s no guarantee of anything. However, the Israelis are highly unlikely to have picked an arbitrary date.
We hope a cooling of hostilities can take place quickly. This would be the best human impact at this point. For markets, the best outcome is for things to remain contained and not expand to targets outside the two countries, which would make a bad situation worse.
It’s critical to recognize and understand how this conflict put equities under pressure early in the week that didn’t subside. The risk of potential U.S. involvement was causing anxiety.
Many argue this could be the catalyst for stocks to start declining. But we believe it’s too early for investors to take this view.
This was reflected last Tuesday when equities were under pressure as oil prices increased. On the surface, this could raise concerns.
But when we analyze risk, we look at two crucial data points: high yield spreads and the CBOE Volatility Index (VIX), commonly referred to as the market’s “fear gauge.” We think these metrics are the strongest arbiters of markets.
Last Tuesday VIX closed near 22, which is slightly elevated but near levels seen in late May (hardly a period of de-risking):
Furthermore, the high yield adjusted spread early last week was at 355, which is the same level as just 10 days prior.
Based on these two market indicators, it doesn’t seem broad de-risking is imminent.
A More Dovish Bias
In the midst of all of the geopolitical events, some may have missed last week’s Federal Reserve decision to hold rates steady and the subsequent press conference.
We didn’t expect the Fed to cut rates. Despite the non-action, we think Chair Jerome Powell’s commentary will ultimately be supportive of stocks because two cuts are still on the table for 2025.
And even though the “wait and see” approach is still prominent, data shows inflation has been decreasing for some time and is undershooting Fed expectations. The data-based central bank will have to acknowledge that fact at some point.
Still, the Fed’s belief of continued tariff uncertainty is the reasoning Powell is still using to put rate cuts on hold. But even market-based measures show future expectations for inflation at their lowest levels in a year:
We think this data will begin to force the Fed to acknowledge this and return to a more dovish bias.
If so, this increases the probability that the historically high amount of money market fund assets will begin flowing back into equities:
A more dovish Fed that’s increasingly supportive of equities will strengthen the resiliency of the stock market in the face of geopolitical disruption. Hopefully, it’s long enough for cooler heads to prevail. We could be wrong, but when in doubt, we turn to data and logic to test the thesis.
Our friends at MoneyFlows (formerly MAPsignals) did a great job reviewing similar Middle East events over the past 20 years. Optimistically we can hope forward returns mirror something like the chart below as stocks have performed just fine an average of 80% of the time:
Yes, this is a small sample size. Thus, it’s important to follow real-time money flow data.
MoneyFlows’ trusty Big Money Index (BMI) – a 25-day moving average of netted “big money” investor activity – is still holding right around 83%:
With the BMI holding for now, we’ll operate under the assumption the market isn’t emotionally overreacting until we begin to see contrary data.
How can we be sure? Well, there hasn’t been an explosion of outflows from “big money” investors:
Also, when looking at individual sector action, money is flowing into bullish sectors, including industrials, technology, and financials:
These are all cyclical growth sectors. And they’re all in the top five, even in the face of conflict.
Looking underneath the surface for more meaning, let’s dive a bit into the most bullish cyclical growth sector – technology. MoneyFlows data shows strong inflows into software stocks, which is one of the most bullish growth subsectors within technology:
For now, the data is clear. The investors who truly move the market – “big money” – aren’t de-risking yet, but in fact are still buying. And until this data changes, we’ll continue to be confidently resilient through this most recent unfortunate geopolitical event.
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