Israel

October seasonality tends to be negative for stocks in an election year. That is the only thing that has stayed our hand from shifting out of our tactical underweight on US equities, initiated – poorly – in July.
But the big macro news from September has not been bearish. The Fed has signaled jumbo cuts. Within seven weeks, the US central bank intends to cut by 100bps! Meanwhile, China appears to have reached a “policy bottom,” with its September 26 Politburo meeting signaling an extraordinary rhetorical shift towards fiscal policy. As such, we are starting to sniff out global reflation, akin to the 2015-2016 mid-cycle slowdown.
The labor market data still worries us. It is clearly deteriorating, on paper. Is it because of an imminent recession or “normalization?” It is difficult to say. We are open minded.
Finally, the Middle East tensions are again on the horizon. If Iran stays its hand against Saudi energy facilities – which we expect it to continue to do – the Iran-Israel conflict is a sideshow. Nonetheless, with global reflation afoot, we went long oil last week, on September 26. As such, geopolitics is a neat tailwind to that call.

Markets are rallying on Fed rate cuts and China stimulus but there will also be October surprises ahead of the US election, which Trump could still win. Russia’s conflict with the West is escalating and the Middle East is destabilizing further. Investors should favor US bonds but they should add some risk in emerging markets in response to China’s policy turn.

Investors should de-risk tactically in expectation of shocks and surprises ahead of the US election and an uncertain aftermath. Democratic victory with a gridlocked Congress is our base case but would bring minor tax hikes and nuclear brinksmanship with Russia. A Republican single-party sweep offers huge tax cuts but also a global trade war. Recession looms regardless.

Investors should buy protection against further volatility. The shakeup in early August was a taste of things to come. The US election is a pivotal moment in modern history that will drive up uncertainty, while other countries take advantage of US division and distraction.

The war in the Middle East is expanding, upgrading our subjective odds of a major oil supply shock to 37% and underscoring our 60% odds of Republican victory in November. Volatility should spike again as investors contemplate the prospect of rising oil prices amid slowing US and global growth. Tactically investors should stay overweight energy stocks relative to other cyclicals and favor oil producers in the Americas rather than Middle East.

Investors should overweight US assets and de-risk their portfolios in anticipation of a major increase in policy uncertainty and geopolitical risk surrounding the US election and its global ramifications.

The death of the Iranian president reinforces our base case view of Middle Eastern instability and at least minor oil supply shocks. Rapid geopolitical developments in recent weeks are pointing to a new bout of global instability. The US is hobbled by its election. Conflicts with Russia, China, and Iran are all now escalating at the same time, at least marginally. Investors should reduce risk and shift to more defensive assets, markets, and sectors.

The implication is that Israel chose not to escalate the risk of direct war with Iran. Hence we remain in our base-case “Minor War, Minor Oil Shock” scenario.

In the near term, favor oil and oil producers outside the Gulf Arab states. Over a 12-month horizon, favor US and North American equities, defensive sectors over cyclicals, and safe-assets. Within cyclicals, stick to energy and defense.

Stay overweight US equities versus world, long US energy sector versus Middle East stocks, and long Canada and Mexico versus global-ex-US stocks.