The recent geopolitical events in the Middle East have caused a contained reaction in the US stock market, with the S&P 500 experiencing a modest decline but then recovering. According to UBS’s thematic basket analysis, the UBS Momentum basket is up 2.1%, providing some relief to investors. The ISM Manufacturing print also contributed to improved sentiment, with Short-Cycle Industrials flat on the day.

Interestingly, UBS’s Middle East Risk basket has seen a significant increase of 3.2%, driven by gains in Exploration and Production stocks and Defense Primes. However, Cyclicals (ex-Energy) versus Defensives are down 2.1%, representing the main pocket of weakness.

As we monitor the market’s reaction to geopolitical events, there are three key risks to keep an eye on:

• VIX: Rising stock and sector correlations could lead to higher index volatility, potentially undermining the systematic bid that has supported equities. Commodity Trading Advisors (CTAs) remain 81st percentile long equities.
• Crude: The impact of elevated spot prices on the market will be critical to watch. How high and how long crude prices stay elevated could have significant implications for investor sentiment.
• Federal Reserve reaction: A repricing of rate cuts due to energy-driven inflation would be a negative development for the market, particularly given the current stage of the economic cycle.