ESLT - Israel/Hamas Conflict: Very Little Heft In Mid-Term Market Outlook

2023-10-17 05:01:03 ET

Summary

• Hamas' bloody attack on Israeli civilians heralds a long military operation in Gaza, which will be costly in more ways than one.
• Unlike past Arab/Israeli conflicts, market expectations seem to be leaning on little to no direct intervention from the Arab world. However, there is some possibility of a direct U.S./Iran confrontation.
• The Middle East is currently witnessing significant flare-ups in other regions, particularly in Syria and Yemen.
• While the Israeli market is trending downwards, oil seems to be holding steady, while U.S. equity markets are witnessing select flows due to the longest bond bear market in history.
• Israel and Ukraine - as well as conflicts in other parts of the Middle East and the world - contribute to uncertainty in the long-term market outlook. In the mid-term, the Israel/Hamas conflict seems to have been "factored out.

As per a number of accounts from sources close to Hamas as well as its own spokesperson on its Telegram channel, Hamas' leadership spent a number of years preparing for the breakout assault on Israel in a bid to challenge the status quo. Dubbed "Operation Al-Aqsa Flood", Hamas and its allies surged into southern Israel using trucks, pickup trucks, motorcycles, bulldozers, speedboats and paragliders to inflict the bloodiest day in Israel's history on the 7th of October.

The events that unfolded since had a number of limited effects on markets worldwide. While a number of banks have highlighted uncertainty in the year ahead on account of the events unfolding in Israel as well as the deepening crisis in Ukraine, markets are generally expected to continue "as-is" for now on account of a variety of macroeconomic factors.

Judea: Past and Present

While the earliest historical examples of expulsions of Jews were estimated to be somewhere around the 7th century BCE during the reigns of Tiglath-Pileser III and Sargon II of the Assyrian Empire, it has been hypothesized that the numbers resettled into other regions were quite low (typically in the few thousands ) and accompanied by generally fair treatment afterwards. A "resettlement policy" was generally the norm of victors of that era in the aftermath of conquest or rebellion. Furthermore, emigrations were estimated to have been fairly common all the way through the beginning years of the Common Era ((CE)), resulting in sizeable Jewish communities in Egypt, Crete, Rome and other places.

With the destruction of the Second Jewish Temple after the siege of Jerusalem during the First Jewish-Roman War in 70 CE came the decline of Judaism's Temple-based sects, a bar on entry to Jews into the Roman colony of Aelia Capitolia (centered around Jerusalem), the rise of Rabbinic Judaism as the mainstream form of religion and the foundations of the Bar Kokhba revolt nearly 60 years later. The aftermath of that revolt is estimated to have resulted in a massive depopulation of the Jewish communities around Jerusalem, albeit without a "resettlement" by the Roman victors. The decline of the Roman Empire across several centuries, varying points of conquests by Arab empires and dynasties across the Levant and the Crusades also played a hand in varying ways in dispersing the Jews out of the Levant.

Towards the end of the 19th century, rising sentiments regarding Jews in both Europe and the Ottoman Empire led to the creation of Jewish organizations "making aliyah" ("going up", i.e. towards Jerusalem), which the horrors of the Second World War and the Holocaust perpetrated by the Third Reich intensified. This movement came to clash with the rising forces of "Arab nationalism" (itself a product of self-determination against colonial occupiers) which intensified after the foundation of the State of Israel and decolonization of the Arab world. Numerous wars broke out, with Israel ultimately prevailing in nearly every conflict. Over the course of the century through 2020 , it is estimated that over 169,000 Arabs/Palestinians and 61,000 Jews/Israelis have been killed or wounded. The economic cost could be in untold billions of dollars.

Hamas' recent actions against Israel extend this human and economic cost even further. With over 1,300 confirmed dead in Israel (mostly civilians) and upwards of 150-200 hostages from all over the world at the hands of an organization widely sanctioned as a terror group that has been in firm control of the 365 square-kilometer Gaza Strip that is home to over two million Palestinians for almost two decades now, it is the single deadliest attack in Israel's history. From a nation-state's perspective, it is an attack that cannot go unanswered. Israeli Defence Minister Yoav Gallant said on October 9 , "Hamas wanted a change and it will get one. What was in Gaza will no longer be."

Almost all of Gaza's liquid fuel, half of its electricity and roughly around 10% of its potable water is supplied by Israel. All of these were cut off by Israel immediately following the attack. However, international pressure has resulted in water supply to southern Gaza - where the Israeli government has been urging Gazans to flee to in order to avoid an upcoming ground offensive - being restored on the 15th of October. Electricity and fuel supplies into Gaza remain suspended. The Rafah crossing - Gaza's only connection to Egypt - remain sealed by the Egyptian government as of Sunday, with Israel refusing to accept the inflow of aid in exchange for foreigners being allowed passage.

Former Hamas leader Khaled Meshaal, based in Qatar, said that the governments and peoples of Jordan, Syria, Lebanon and Egypt have a bigger duty to support the Palestinians and called upon Muslims to take to the streets this past Friday to demonstrate against Israel, thousands of protestors descended into public squares after Friday prayers in Baghdad (Iraq), Beirut (Lebanon), Amman (Jordan), Teheran (Iran) and Sanaa (Yemen). Flag burnings and protests also occurred in Pakistan, Bangladesh and Malaysia. While it was earlier reported that the Taliban regime in Afghanistan contacted Iran, Iraq and Jordan for passage so that its troops could join with Hamas fighters, the regime later clarified that this was not true . The countries with the largest share of the Muslim population in the world (around half a billion) - India and Indonesia - saw muted and civil protests in thinly-attended rallies.

The Israel/Palestine issue has been central in U.S. polity regarding the Middle East. As of March this year, a Gallup survey shows a marked shift on the basis of party affiliation since 2001.

Since 2014, Democrat respondents have largely trended downwards in support of Israel while Republicans have held steady. The former favoured Palestinians over Israelis 49% to 38%. Among the latter, nearly eight in 10 (78%) continue to sympathize more with the Israelis while 11% side with the Palestinians.

Among age groups, Millennials (born between 1980 and 2000) show the largest dip in sympathy for Israelis in favour of Palestinians.

This disparity in support likely tempers the current administration's messaging and specifics with regard to the situation. Given that the U.S. is by far Israel's most significant strategic partner, this is of significance.

Market Trends This Past Week

Since the start of the market, Israel's Tel Aviv Composite Index as well as the popular short-breadth large-cap Tel Aviv 35 (TA35) and broader large-cap Tel Aviv 125 (TA125) indices have had significant wind downs.

As of market close on the 15th, the three indices fell by -12.6%, -12.0% and -11.8% respectively. Israel's central bank announced its first-ever sale of foreign exchange , to the tune of $30 billion, in the open market to maintain the New Israeli Shekel's stability during the war with Gaza.

Over the past week, crude oil (WTI and Brent) broke its downward trajectory with a quick hike mid-week, following which prices have been holding steady at a little over the $90 mark over the weekend.

Earlier deflationary trends - a byproduct of forward-looking recessionary concerns impacting consumption and driving down demand in the Western Hemisphere - were somewhat firmed up due to potential supply disruptions in the future. However, overall concerns aren't very high.

The past week also recorded a rare and extreme upward streak among U.S. arms manufacturer stocks, which also had fairly recessionary downtrends. Over the past week, U.S. military stocks gained nearly $30 billion in market capitalization - with Lockheed Martin ( LMT ), Northrop Grumman ( NOC ), L3Harris ( LHX ), RTX ( RTX ) and General Dynamics ( GD ) leading the charge.

European military stocks witnessed a similar phenomenon as well:

However, it bears noting that stock analysts are calling this to be a momentary blip: the Israel-Hamas conflict is relatively small scale while long-term crises such as the Cold War and the war in Iraq tend to be long-term growth drivers for the sector.

Interestingly, markets have been largely positive over the past week. In the S&P 500 ( SPY ), the Top 25 stocks by momentum outperformed the index +0.57% vs +0.45%.

The majority of the index change was wrought by tech stocks, which was amplified within the Nasdaq-100 ( NDX ): the Top 25 list outperformed the index +0.51% vs +0.15%.

While the oil outlook and the present direction of the market might seem contradictory, this is not the case. A prime factor behind the market's overall market performance has been what Bank of America - in a note dated October 6 - called the " greatest bond bear market of all time ". Bond funds saw $2.5 billion in outflows till the Wednesday of that week due to yields on 30-year Treasuries rising above 5% for the first time since 2007. The current loss in 30-year bonds from the peak in the market in July 2020 to now far outpaces that of any previous bear market, with buy-ins into bond being termed a "humiliation trade".

However, the bank says there's no capitulation: Treasuries funds continued to see inflows of $4.6 billion in that week albeit with a preference for shorter-term paper due to which yields on 2-year Treasuries fell 9 basis points

The overall effect on the market has been extremely poor equity breadth, with pile-ons into select stocks to balance out portfolios now overloaded with increasingly unmarketable long-term bonds. High-yield "junk bonds" have also been taking a beating since these select stocks are implied to be more survivable in a high-rate environment than issuers of junk bonds that are more sensitive to high interest expenses.

In Conclusion

The Middle East is a complex motif of intertwining identities, historical iniquities and grievances carried over across generations and centuries, which continues to exact a toll on the various peoples therein. So central is Israel/Palestine to Western policymakers that nearly all else is obscured. On the 5th of October, U.S. ally Turkey initiated a series of airstrikes that destroyed nearly half of U.S.-allied Kurdish power and oil infrastructure in northeast Syria's Hasakeh province. U.S. forces in the area did little but shoot down a Turkish drone that approached them. On the same day as the drone incident, yet another set of drones killed scores of Syrians attending a military graduation ceremony in the city of Homs. Since then, Russian-backed Syrian forces have been bombarding Idlib province (held by Al Qaeda affiliate Tahrir al-Sham) and Turkish-held Aleppo province, collectively home to 4.5 million people. Nearly 70,000 people are estimated to have been displaced, with many more expected. Late last month, Yemen's Houthi fighters attacked Bahraini forces that were part of a Saudi-led coalition on the Saudi-Yemen border via a drone, endangering ceasefire talks that have been going on for over a year now to end a crippling 7-year war waged across Yemen.

There is absolutely no doubt that Israeli forces are looking at a long and grueling campaign in their bid to uproot Hamas. The epicenter of the fighting is expected to be the decaying and increasingly cratered urban sprawl that is Gaza City, with an extensive warren of tunnels under the entirety region for Hamas fighters to move through. By Hamas' own claim, the Strip - which is about 41km long and 10km wide - has over 500 km of tunnels secretly built up over the years. Israel's military expects heavy casualties and aims to incur them at a very high cost to the opposition and is proceeding despite Iran's repeated statements that it will get directly involved if the ground offensive begins. Israel's equity markets and economic health is a distant second to the task at hand.

However, Israeli equities' total contribution to global market performance is fairly light. The disparity seen in Israeli market performance can be attributed to relatively lower consumption expected as the nation mobilizes for months-long war. Incidentally, the overall trends in military stock performance can be seen in Israel as well: over the past 5 days, Elbit Systems ( ESLT ) has risen nearly 7%. Overall, market trajectories indicate an underlying impression that the Middle East and its chain of crises is essentially "factored out" of market estimations for the most part. There is very little expectation that the Israel-Hamas conflict would drag in the rest of the Arab world in a significant manner.

While U.S. equity markets might look like they're doing well, several "leading" stocks are increasingly approaching "overheated" due to market flows with no significantly meaningful macroeconomic indicators for the upside and very little of import being conveyed from Middle Eastern conflicts. Periodic waves and troughs can be expected, as seen over the past several weeks. Caveat emptor.

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