As Wall Street works to absorb the impact of the Iran conflict, U.S. stock markets have experienced a period of significant volatility. However, as the conflict enters its third week, signs indicate the worst may be behind us, with investors adopting a more optimistic stance toward equities. Concerns, of course, remain. Rising oil prices, driven by the closure of the Strait of Hormuz, threaten to push inflation higher, reducing the likelihood of Federal Reserve interest rate cuts while increasing the risk of an economic slowdown or even recession. Supply chains across multiple industries, from metals and raw materials to food and pharmaceuticals, face threats. Furthermore, pre-existing worries that dampened market sentiment before the conflict, such as the impact of artificial intelligence and exposure to private credit risks, have not dissipated. Nevertheless, even without signs of the conflict abating, investment experts appear to have learned to coexist with geopolitical uncertainty. The S&P 500 index rose 1.3% this week, marking its best two-day performance since the U.S.-Israel airstrikes began, and now sits just 3.8% below its January record high. Meanwhile, options traders are gradually unwinding some bearish bets, and a recent decline in investor equity exposure may signal the market is finding a bottom. "The question is: Why aren't they panicking because of this?" said Sam Stovall, chief investment strategist at CFRA. He noted that the current decline remains below the threshold for a correction, stating, "I think, in many ways, the market's resilience is encouraging investors, and the continued improvement in earnings growth expectations may be the underlying reason supporting the market's foundation." Earlier this month, the cost of options hedging against a 5% decline in the SPDR S&P 500 ETF surged to its highest level in over a year relative to the cost of hedging a similar gain, but this premium is now gradually receding. The calm in the CBOE Volatility Index (VIX) is evident. The index touched 35 on March 9, a signal of heightened market anxiety, but has since retreated, closing near 22 on Tuesday. Barclays derivatives strategists noted that weak demand for options betting on a VIX spike, combined with outflows from exchange-traded products that go long on the VIX, indicates investors are not succumbing to panic. Noah Weisberger, chief strategist at BCA Research, stated that despite increased market volatility, the S&P 500's decline has been "relatively modest." A more significant drop is still possible, but the fact that it has taken considerable time to fall just 5% could be a positive signal. In early New York trading, S&P 500 futures were up 0.5%. If the index finishes the week down 5% from its recent high, this correction process will have taken over 47 days. CFRA data shows that since World War II, the S&P 500 has never fallen into a bear market after a 5% correction that took more than 40 days. The element of time may also be playing a role in improving market sentiment. Samir Samana, global head of equity and real assets at the Wells Fargo Investment Institute, believes that heightened geopolitical uncertainty is "nothing new" for Wall Street, with the only change being a shift in the "epicenter." Given that, barring a significant portion of the global economy teetering, sharp sell-offs have historically been brief, investors might be better served by "diversifying their allocations rather than trying to escape each new individual conflict." As for when the S&P 500 might reach a new high, CFRA's Stovall suggested that any potential sign of conflict resolution could ignite a rally. "If we see at least negotiations taking place, which could clearly mean an end to hostilities and lower oil prices, I think that would be a trigger," he said. "Even the prospect of talks, I think, would greatly help the market recover and attempt to make a new high." Samana is looking for a more specific initial catalyst: the reopening of the Strait of Hormuz. If the strait reopens quickly, the market would then look for the next signal; but if the blockade persists, it could pressure investors. "If the strait reopens, we might enter a period of range-bound trading until other uncertainties clear up," Samana said. "If the strait remains closed for months, then the potential for a sharp rise in oil prices could cause the S&P 500 to break below the key support level of its 200-day moving average, potentially leading retail investors to sell at a loss."
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