U.S. stock rally could wobble if tensions spike after Red Sea attacks

Traders work on the floor at the New York Stock Exchange (NYSE) in New York City, U.S., Dec 1, 2023. REUTERS/Brendan McDermid/File photo

An attack on an American warship and commercial vessels in the Red Sea on Sunday risks reigniting investor worries about a widening of the war between Israel and Hamas, potentially complicating the outlook for a rally that saw U.S. stocks crest a fresh closing high for the year last week.

The Pentagon said it was aware of reports regarding attacks on an American warship and commercial vessels in the Red Sea on Sunday, while Yemen’s Houthi group claimed drone and missile attacks on two Israeli vessels in the area.

Also on Sunday, a U.S. military official told Reuters the United States carried out a self-defense strike in Iraq against an “imminent threat” at a drone staging site.

The developments risk inflaming fears that the Israel-Hamas war could widen into a broader conflict encompassing the U.S. and regional players like Iran. Such worries flared after Hamas’ Oct. 7 attack into southern Israel but subsided in recent weeks.

Quincy Krosby, chief global strategist at LPL Financial, said a widening conflict could push some investors to take profits on the recent rally in stocks. The S&P 500 rose nearly 9% in November on signs of easing inflation and hopes the Federal Reserve is done raising interest rates. The index is up almost 20% on the year after notching a 2023 closing high on Friday at 4594.63.

“The market is sensitive to any expansion of this conflict,” she said. “I think active managers in any event are more likely to lock in their gains if this is a harbinger of a deeper military conflict that involves the US.”

Past spikes in geopolitical tensions have made investors head for popular havens such as gold, Treasuries and the U.S. dollar. Signs of an intensifying Middle East conflict could also boost oil prices, which have slumped in recent weeks.

Phil Orlando, chief equity market strategist at Federated Hermes, said rising tensions in the region could send West Texas Intermediate crude prices up to between $80 and $90 per barrel. Prices on Friday stood at $74.07.

The developments come as investors eye factors that could sway stocks in coming weeks. A U.S. employment report due on Friday could bolster the case for those arguing that a cooling economy will keep the Fed from raising interest rates further and possibly loosen monetary policy sooner than expected.

READ: Tax-loss selling, ‘Santa rally’ could sway U.S. stocks after Nov melt-up

Other potential catalysts include the Fed’s monetary policy meeting on Dec. 12-13, as well as seasonal factors such as tax-loss selling and the so-called Santa Claus rally.

Orlando said a spike in geopolitical tensions could drop the S&P 500 by “one or two hundred points.”

“There’s no question this represents an opportunity for investors to take profits,” he said. “However I’m still convinced the index ends the year at 4,600.”