Absorbing a Middle East Shock

War in the Middle East – again... Terrorists attack Israel... Hundreds killed and kidnapped... The response has already begun... The wide-reaching impact... The biggest move in the markets today... What else to watch...

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The world is watching war in the Middle East – again...

To recap the Hamas terrorist group's attack on Israel that began Saturday morning, here's the summary from CBS News...

They stormed into Israel by land, sea and even on paragliders as waves of rockets – more than 3,000 of them – were unleashed on Israeli towns and cities.

The gunmen from the group, which has long been designated a terrorist organization by the U.S. and Israel, went on a rampage, slaughtering civilians in the streets, engaging Israeli security forces with deadly effect, and kidnapping hostages including women, children and the elderly.

Some of them were paraded through the streets of Gaza – human trophies that Hamas knows it can use as leverage against its enemy.

I (Corey McLaughlin) don't expect you to get your mainstream news from the Digest. But today, I'm going to recap the still-unfolding events in Israel so that we can consider what it might mean for the world, the markets, and your investments.

Now, we know peace in the Middle East has long been elusive and debated. Rockets flying in the sky have become routine in the region's cycle of violence.

But in case you've grown immune to hearing about violence in the region, understand that what happened over the weekend was unprecedented. Here's more from CBS as of our press time...

An Israeli embassy spokesperson said Monday the death toll has risen to at least 900 Israelis, most of them civilians. Another 2,150 were reported wounded. More than 250 of the dead were Israelis who came under attack at the Supernova music festival near the border with Gaza when militants opened fire on the crowd.

Israeli officials also say Hamas fighters captured more than 100 hostages, including women, children and elderly people, who were apparently taken into Gaza as captives.

Some observers have likened the events to an equivalent of 9/11 in Israel.

Hamas militants launched bombs and missiles from Gaza, a tiny strip along the Mediterranean Sea, and the group's fighters crossed deep into Israeli territory... bringing captives back with them in an attack that appears to have taken Israel's leadership off guard.

The response has already begun... The Israeli government has reportedly drafted 300,000 reservists into the military and began bombing suspected Hamas locations in Gaza within hours of the Saturday morning attack, destroying buildings. Hundreds of Palestinians are also dead and thousands are wounded.

Suddenly an unknown number of Israeli hostages (estimated to be at least 150 as of this writing) are caught in the crossfire, with their fates in question. So is the state of the entire conflict – and region.

The suspected catalyst...

We're going to get into some political science for a moment... Here's what I can tell you about recent history – and I'm bringing all this up because it leads to an effect on oil supply and inflation (potentially in a big way).

Geopolitical and regional experts point to recent developments in Middle East political relations as being a possible trigger for the attack. Other factors include recent political infighting in Israel that left the country vulnerable, along with Israel's focus lately on the West Bank – the Palestinian territory that borders the other side of the country – rather than the Gaza Strip.

Hamas took over the Gaza Strip in 2007, which divided the Palestinian territories politically. Palestinian leaders in the West Bank have been more recognized internationally while, as we said, Hamas is considered a terrorist group by the U.S. and Israel.

Among other conflicts, in 2014 Israel arrested hundreds of Palestinians – some of whom may become part of prisoner swaps for Hamas' new Israeli hostages.

Within this context, columnist Thomas Friedman wrote a multilayered piece in the New York Times over the weekend, citing the possible trigger – a cozier relationship that had been brewing between Saudi Arabia and Israel with respect to the West Bank.

Here's what that means... Saudi Arabia was apparently on the verge of "normalizing" relations with Israel, meaning recognizing it diplomatically. That's in contrast with, say, rival Iran. In exchange, the Saudis were seeking U.S. help to develop a "civilian nuclear program" in Saudi Arabia, while also providing "security guarantees" and encouraging Palestinian development of the West Bank.

Friedman wrote...

Such a deal, as it was being drawn up, would... benefit the more moderate West Bank Palestinian Authority – by delivering it a huge infusion of cash from Saudi Arabia, as well as curbs on Israeli settlements in the West Bank and other advances to preserve a two-state solution. As a result, West Bank leaders might have earned a desperately needed boost of legitimacy from the Palestinian masses, threatening the legitimacy of Hamas.

Hamas may have taken these developments as a threat. A Saudi-Israeli deal could be a step toward a peaceful "two-state solution" in the region and other victories for the more moderate Palestinian leadership in the West Bank. That would undermine support for the Hamas group in Gaza, southeast of Israel.

Friedman also suggested Iran might have had an influence. Friedman offered...

Why did Hamas launch this war now, without any immediate provocation? One has to wonder if it was not on behalf of the Palestinian people but rather at the behest of Iran, an important supplier of money and arms to Hamas, to help prevent the budding normalization of relations between Saudi Arabia, Iran's rival, and Israel.

There's a lot to digest in this summary and hypothesis. And if you are to believe U.S. Secretary of State Antony Blinken, Hamas' precise motivation remains unclear... But just know there are many strands to this story, many of which connect seemingly disparate nations and interests in the Middle East and beyond.

Those interests are also, in one way or another, connected to one common commodity that has a large influence in the economy and markets...

The greatest direct impact on the markets today was on oil prices...

When we look at the performance in the markets today as investors digested the developments from the weekend, one thing stands out... a shock for oil prices.

Brent crude – the international benchmark – traded more than 4% higher to around $87 per barrel. West Texas Intermediate ("WTI") – the U.S. standard – saw a similar move.

By association, energy stocks finished up more than 3%, the highest of the 11 major S&P 500 sectors. Notably, the "chaos hedge" of gold was also up 1%... Yet in the afternoon, the major U.S. indexes turned small losses into gains to also finish the day positive.

As Stansberry NewsWire editor Kevin Sanford noted today, both Brent and WTI crude have seen notable surges over the past few months yet experienced significant losses last week. But that trend paused today...

Analysts express concern that weak global growth might adversely affect oil demand as we head into next year. However, heightened tensions and recent conflict in the Middle East have reignited apprehensions about oil being entangled in geopolitical crosshairs, possibly causing a short-term rise in oil prices.

The opposite effect – so far...

Interestingly, an escalating war in and around Israel and higher oil prices are reportedly the precise messes the White House was seeking to avoid by trying to broker a negotiation with Saudi Arabia. Here's NBC News today...

Diplomats say that if Saudi Arabia agreed to recognize Israel it would lead other Arab states to do so. A series of such agreements would end decades of hostility between Israel and its neighbors dating back to 1948.

All three sides, though, have complex conditions for such an agreement. Breaking with past Saudi rulers, [Saudi Crown Prince Mohammed] bin Salman has signaled that he is willing to recognize Israel, given the vast economic benefits it would provide to Saudi Arabia. Before the Hamas attack, there were reports that Saudi Arabia had told the White House it would agree to increase its oil production to help cement a deal, something the Biden White House has sought for two years.

As we said when Russia invaded Ukraine, and now can sadly repeat 18 months later, war is ultimately an inflationary pressure – for myriad reasons depending on the context, including creating commodity-supply issues.

Russia and Ukraine, for instance, are tied to global supplies of food and oil. And in the Middle East, many battles have been fought over the decades... with oil concerns squarely in the middle of many disputes.

Predictably unpredictable effects – except one thing...

This appears to be another bloody, horrific conflict that is only in its early days. Developments in Israel's war against Hamas in Gaza will likely change the calculus of relationships not just between the enemies, but also among global powers like the U.S., Saudi Arabia, Iran, and others in ways that we can't predict.

Already today, for example, Germany and Austria announced they are suspending aid worth tens of millions of euros to Palestinians – drawing battle lines in their association with the conflict. The U.S. has moved warships closer to Israel and is promising to help by providing resources to the Israeli Defense Force.

Here's more from Friedman...

This is not your usual Hamas-Israel dust-up. The Gaza-Israel border is only 37 miles long, but the shock waves this war will unleash will not only thrust Israel and the Palestinians of Gaza into turmoil but will also slam into Ukraine and Saudi Arabia and most likely Iran. Why? Any prolonged Israel-Hamas war could divert more U.S. military equipment needed by Kyiv to Tel Aviv, and it will make the proposed Saudi-Israeli normalization deal impossible – for now. And if it turns out that Iran encouraged the Hamas attack to scuttle that Israeli-Saudi deal, it could raise tensions between Israel and Iran and Tehran's Lebanese proxy, Hezbollah, and also between Saudi Arabia and Iran. This is an incredibly dangerous moment on multiple fronts.

According to the Washington Post yesterday, citing a U.S. government official...

Washington's direct military assistance for Israel is expected to backfill the munitions that Israel will draw down as it fights Hamas, as well as provide an additional deterrent against Hezbollah, Iran and others who might be tempted to strike Israel.

Overall, when it comes to the markets, a prolonged war in the Middle East isn't likely to slow down inflation or government spending. You could think instead of this weekend's events as contributing to any investing thesis suggesting higher inflation and more debt for longer around the globe.

It could also devolve into an even greater conflict involving the direct and indirect interests of more and more of the globe's biggest and most powerful nations. That would mean more potential to have meaningful influence on policies that can stoke inflation – leading to strife, anxiety, and fear.

One could argue it's already happening.

What else to watch in the markets this week...

We're not looking past what's going on in the Middle East, by any stretch. But there are other matters that investors will be paying attention to this week – and they could influence stock and bond movement, too.

As Kevin also wrote this morning, inflation numbers and the Federal Reserve will be in the headlines again. The latest producer price index – an indicator of costs for businesses – will be published Wednesday morning, and the consumer price index comes out Thursday. As Kevin said...

This week, investors will be closely watching the release of the September Consumer Price Index ("CPI"), which is expected to show a month-over-month increase of 0.4% and an annual increase of 3.7%. The core CPI, which excludes volatile food and gas prices, is projected to rise at an annual rate of 4.2%, which would mark the smallest annual increase since September 2021.

This data will play a significant role in shaping expectations regarding the Fed's future plans. And investors could get a glimpse at those plans with several Fed officials, including Neel Kashkari, Mary Daly, and Christopher Waller, speaking throughout the week.

Third-quarter earnings season also begins in earnest this week, with the big banks reporting their quarterly financials. Notable surveys of small-business owners and consumer sentiment are also on deck to be digested by investors weighing the economic outlook ahead.

New 52-week highs (as of 10/6/23): CBOE Global Markets (CBOE), CME Group (CME), Qualys (QLYS), and Construction Partners (ROAD).

In today's mailbag, feedback on Dan Ferris' latest Friday Digest, which included a free recommendation... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Thanks Dan! When some simple great advice is just too important not to share, you once again stood alone to share with all the subscribers! I applaud your conviction and dedication to subscribers Mr. Ferris!..." – Subscriber Rodger G.

"WOW... Dan, you outdid yourself again. Thanks a million for all the education. Your Friday's Digest was the best mini-lesson on bonds AND investing I've ever read. I can't say 'thank you' enough. I'm excited too, to see how this new type of investing turns out." – Subscriber S.M.

All the best,

Corey McLaughlin
Baltimore, Maryland
October 9, 2023