Equity markets have stayed surprisingly positive during the recent crisis – unlike the hysterical bond markets.
- The S&P 500 was down around 5% in March, trivial in the history of market setbacks
- Markets appear to have placed significant faith in the TACO trade
- While the optimistic side has won out temporarily, there are still huge risks
One of the most surprising elements of the crisis in Iran has been equity markets’ willingness to look on the bright side. Even at the depths of economic pessimism over the impact of the conflict, and when bond and commodities markets were feeling the strain, equity markets appeared largely impervious. How have they been able to keep their spirits up?
The S&P 500 was down around 5% in March. In the history of market setbacks, this is trivial. At the start of the Covid crisis, double-digit falls in a single day were not uncommon. It has been a tougher period for areas such as emerging markets, with the MSCI Emerging Market index down 13.1% over the month, but even there, the index is still flat for the year to date.
The FTSE 100 may not yet be back up to its recent peak of 10,910, but it is still up 6.7% for the year to date. It has been cushioned by its relatively heavy weighting in the oil majors, mining and defence companies. It’s not just equity markets where there has been evidence of complacency. Credit spreads have remained more or less at their level at the start of February.
Markets appear to have placed significant faith in the TACO trade. They have taken Donald Trump at his word, rallying every time he has shown signs of wanting to end the conflict. Plenty of commentators have been surprised at investors’ willingness to believe the President, when his statements have been so capricious and contradictory. However, the market’s view appears to be that it indicates a direction of travel, and that is the swing factor.
If the current ceasefire holds – and that is still a significant ‘if’ – stock markets will have been proved right. If oil starts flowing through the Strait of Hormuz, the economic damage is likely to be limited. The bond market, in contrast, has looked somewhat hysterical. The vacillations in the gilt market are perhaps the clearest example, with markets moving from the expectation of a single rate cut from the Bank of England to three rate rises in a matter of days. Bond markets are supposed to be the sage, temperate corner of financial markets. This episode has damaged that reputation.
Nevertheless, while the optimistic side has won out temporarily, there are still huge risks. The ceasefire is fragile, conceived against a backdrop of complete mistrust. The knock-on effects – through higher bond yields, rising fertiliser prices, and consumer inflation – are yet to be realised. Plus, stock markets look pretty expensive. There is still an argument for treading carefully.
