Monday's Market Traps Investors as a Harsher Reality Hits on Tuesday
The Middle East conflict is widening, and markets are repricing the risk of high oil, energy, and inflation. Here's the warning the the bond market is sending.
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Monday's relatively calm market action proved misleading. Equity markets sank overnight and are sharply lower early Tuesday, with Dow futures pointing to an implied loss of around 865 points at the open.
The mild Monday recovery that looked encouraging for most of the day was not a sign of resilience. It was a pause and a trap before the next leg down.
The Middle East conflict is now in its fourth day and showing clear signs of widening rather than stabilizing. Oil prices pushed higher overnight after Iran threatened to set fire to ships attempting to pass through the Strait of Hormuz. Brent crude topped $82 a barrel overnight. European natural gas prices soared more than 20%, extending Monday's surge.
Futures for the three main U.S. indexes were off at least 1.4% and stocks in Europe and Asia dropped fast with South Korea and Japan leading declines. Europe and Asia are considerably more exposed to Middle Eastern energy supply disruptions than the U.S. and their markets are reflecting that vulnerability.
Monday's Dip Buyers Created a False Sense of Security
Part of what made Monday's action so misleading was the absence of any real fear. Rather than stepping back to assess the situation, dip buyers jumped in aggressively at the open and stayed steady throughout the day. They largely ignored the negative implications of a widening regional conflict and focused on the opportunity created by the initial selloff. That steady buying created FOMO among market participants that wanted to catch a low and produced an aura of safety that the fundamentals did not support.
It did not take much to shatter that optimism. Iran continued striking neighboring countries overnight and the scope of the attacks made clear this is not a contained or quickly resolving situation. The U.S. Embassy in Riyadh was damaged. The UAE reported intercepting more than 180 ballistic and cruise missiles fired from Iran. Those are not the actions of a conflict winding down.
The dip buyers who provided Monday's stability are now sitting on losses and the FOMO crowd that followed them in is in the same position. When that happens, the next wave of selling tends to be more emotional and less orderly than the first.
The Bond Market Is Sending a Warning
The signal worth watching most closely Tuesday morning is not stocks, it is bonds. Concerns that higher energy prices will reignite inflation pushed the 10-year Treasury yield through 4% on Monday and it reached 4.1% overnight.
Normally when stocks sell off sharply bond prices rise and yields fall as investors seek shelter. The opposite is happening. Bonds are selling off alongside stocks because the market believes a sustained spike in energy prices will make the Fed's job considerably harder and delay any prospect of rate cuts further into the future.
That combination of falling stocks and rising yields creates a very difficult environment for equity investors since there is nowhere obvious to hide other than cash.
Game Plan
Monday's dip buyers had a good day right up until they didn't. Those who took quick profits and moved on did fine. Those who held overnight were blindsided and are now underwater on positions they thought were working. The fog of war makes it a serious mistake to assume a bottom too quickly or to trust that a one-day recovery represents a new trend.
Volatility will remain elevated and that changes how we have to operate. If you are going to trade in this environment keep it very short term. Take what the market gives you quickly and be ready to hit the eject button without hesitation. The market will not reward patience with open positions right now.
It is far too early to be building longer-term positions. There may be a handful of names worth putting on the radar and tracking as potential opportunities, but the time to act on them is not now. Watch them, understand them, and wait for the environment to stabilize before committing meaningful capital.
The core issues impacting the market are not going to be resolved quickly or cleanly. Military conflicts of this scope generate reverberations that play out over weeks and months, not days. Each new development brings another round of uncertainty and another wave of volatility. Trying to get ahead of that process is a good way to get hurt. The investors who come out of this period in the best shape will be the ones who preserved their capital during the fog and were ready to act decisively when the picture finally began to clear.
The good news is that out of chaos, great opportunities will develop but timing is the key and that will not be easy.
At the time of publication, Rev Shark had no positions in any securities mentioned.
