Update on Markets’ Responses to War in the Middle East

Over two months after the horrific 10/7 terrorist attack on Israel, its war with Hamas rages on and the world continues watching. While fighting is mostly contained, some events investors feared at the start, like attacks on the region’s oil infrastructure, have come true to an extent, with tankers attacked in the Red Sea in recent days (which we covered earlier this week). Yet markets are moving on, taking the events in stride as they typically do with regional conflict—a powerful reminder that, while the Ukraine war was one contributor to last year’s bear market, most have only a fleeting impact on stocks.

Even with the latest troubles in the Red Sea, global stocks are shrugging the war off, as we would expect given Israel’s tiny shares of MSCI World Index market cap and global GDP. The MSCI World Index hit fresh year-to-date highs in December, fully erasing the late-summer correction, and it has now passed early 2022’s peak when dividends are included.^[i] But even Israeli markets seem to be moving on. In both dollars and shekels, the MSCI Israel Index took a sharp drive after 10/7, falling through the war’s early days. But it bottomed in late October and embarked on a swift, V-shaped recovery. Now, as Exhibit 1 shows, it is above pre-10/7 levels. The shekel itself also weakened dramatically after the attacks, which led the Bank of Israel to intervene in currency markets, seeking stability. But the bank largely ceased those interventions in November and, as Exhibit 2 demonstrates, the shekel kept on re-strengthening.^[ii]

Exhibit 1: The Resilient Israeli Market

Source: FactSet, as of 12/21/2023. MSCI Israel total return in local currency, 6/30/2023 – 12/20/2023.

Exhibit 2: The Resilient Israeli Shekel

Source: FactSet, as of 12/21/2023. US dollar per Israeli shekel, 6/30/2023 – 12/20/2023.

There are other stats we could point to, like the rebound in Middle East tourism, which froze right after the fighting broke out. But overall, it seems clear that markets and people alike are at least unconsciously realizing the fighting isn’t hitting the Israeli or global economy in a meaningful way.

This is how it usually goes. At first, uncertainty over a conflict’s extent roils sentiment in the run-up to (and sometimes immediate aftermath of) the fighting. War is unsettling, frightening and awful. Regional conflict usually comes with the fear of global spillover. Not just in terms of more and bigger nations getting involved, but also via the potential disruption of trade routes, commodity production and the like. But after a few days or weeks, the scope becomes clearer, allowing markets to discount the impact and move forward with the knowledge that the war, while tragic, won’t put a meaningful dent in commerce across the vast majority of the global economy. Accordingly, markets usually bounce well before the war’s endgame becomes apparent.

The Ukraine war may seem an exception to this, but we suspect this is in large part because it collided with a host of other issues already bogging down sentiment, including energy prices, supply chains and inflation in general. It wasn’t the sole contributor to 2022’s bear market, just a major factor exacerbating some of the inflation fears that accompanied it—which fed into rate hike fears as the Fed shifted its policy stance from wait-and-see to swift, steep hikes. Those arguably weighed on sentiment much longer than the conflict itself, tragic though it is. Note, too, that the bear market ended in October 2022, while fighting in Ukraine rages on over a year later.

The cold, hard truth is that while war is awful on a human level, stocks usually see through that. They focus coldly on the impact on publicly traded stocks’ earnings. When the fighting is confined to a corner of the world with minimal impact on those earnings, there is no logical reason for stocks to stay down for long—and every reason for stocks to rally as investors realize, however subconsciously, that their initial fears overshot.