The U.S. stock market was basically flat this past week for the second week in a row. The S&P 500 Index rose 0.5% through Friday’s close. Although equities logged their first back-to-back weekly increases since August, sentiment remains cautious as investors consider the geopolitical implications of the rapidly-evolving Israel-Gaza conflict and the possible macro effects from the recent increase in Treasury yields.
The benchmark yield fell for the first time on a weekly basis in six weeks, settling at 4.63%.
The stock market’s modest decline last week may come as a surprise, given the escalating war between Israel and Hamas, which governs the Gaza Strip. The primary reason for those gains had little to do with the hostilities, but rather were a result of growing expectations that the Fed will extend its pause on raising interest rates due to the recent rise in long-term Treasury yields. Dallas Fed President Lorie Logan said as much on Monday. “If long-term interest rates remain elevated because of higher term premiums, there may be less need to raise the Fed funds rate”, she reasoned.
Even though Mr. Market seems unconcerned, I believe investors ignore the Israeli- Hamas conflict at their own peril. If the conflict remains contained to Israel and Hamas, the impact on the markets will likely be minimal. The big question is whether Hamas was acting in concert with Iran? If so, the U.S. and other nations outside the region could get dragged into the fighting, in which event the stock market is likely to suffer.
Were that to happen, there might be a surge in demand for long-term Treasuries, which would reduce yields, which in turn might convince the Fed to enact additional rate hikes. Moreover, the Israeli-Hamas War is not the only threat to the stock market. The bond selloff, the burgeoning federal deficit, high interest rates, inflation, and the dysfunction in Washington could potentially all trigger a market sell-off before the year’s end.
Considering these uncertainties, last week we temporarily reduced the equity allocation in our model portfolios to approximately 5% below the level called for by our investment strategies’ model portfolios. We have moved that share of our client portfolios into a Fidelity money market fund, which is currently yielding approximately 5%.
If stocks rally while this defensive measure is in place, this trade could reduce account performance a bit. But it would also mean stocks held in the portfolios rose by more than 5% while our precautionary hedge is in effect, which would be a welcome development.
That’s all for now. Have a great weekend and invest wisely my friends.