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Israel at War – Implications for the Market

This piece was originally published on October 9th, 2023.

Introduction:

Over the weekend Hamas attacked Israel killing and kidnapping hundreds, or possibly, thousands. Israel has declared war and has begun a counter-attack. As usual, DKI will focus on policy and the market/economic implications of events, and as much as possible, will leave the politics to others. I also note the old anecdote that in times of war, truth is the first casualty. There are already claims that some of the photos and video emerging are fake, staged, or taken from other conflicts. I have no way to verify individual pieces of information, and will change my opinions if the information I consider to be credible changes.

The Timing:

I believe Hamas chose this timing for two reasons. First, Israel and Saudi Arabia have been making progress towards improving and normalizing relations. A war between Israel and  terrorist groups like Hamas and Hezbollah will complicate and possibly delay an agreement with Saudi Arabia.

Second, I’ve read reports that much of Israel’s munitions have previously been sent to Ukraine. If true, this leaves Israel with limited firepower from the ground. Trying to regain control of Gaza using ground troops in an urban setting would be very difficult and result in high casualties. While the White House has made supportive comments regarding Israel, the US is short on munitions for the same reason Israel is:  Much of this equipment has been sent to Ukraine.

The Markets:

On Sunday night, the equity index futures were down almost 1% which is a relatively large move. When I started writing this piece, stocks had recovered most of their losses. I then took an hour to take a research call, and now, stocks are up solidly on the day. The advance is being led by the defense sector stocks on the correct speculation that events will lead to more spending on weapons. There was a narrative earlier about a flight to safety indicating that people would sell stocks and buy bonds, but it’s hard to tell if that will be the case given that stocks have reversed their losses and the US bond markets are closed for Columbus Day.

Gold is up reflecting the real flight to safety trade.

Bitcoin is down a little. Long-term, I believe Bitcoin will trade like gold; as a flight to safety trade. In the short-term it still trades as a risk asset meaning it gets sold with stocks. Rational or not, Bitcoin has traded like a high beta (high-volatility) pair to the equity markets. Bitcoin has started to reverse losses on the day with the recovery in equities, but as I write this, remains down slightly.

Oil:

Energy markets are predictably higher. Every time there’s conflict in the Middle East, oil prices rise. This is further complicated by Iran’s rumored direct involvement in helping Hamas plan its attack. The US has relaxed enforcement of limitations on Iran’s exports of oil in order to put more pressure on Russia. The weekend’s events will now pressure Washington DC to do something to indicate displeasure with Iran.

VIX:

I’ve said before that the $VIX, a measure of projected market volatility, remains low relative to the large number of extraordinary risks present right now. At the time, a war between Israel and Hamas wasn’t even being considered. Today is one of those unusual situations where stocks and the VIX are both up together. I still own a very small position in $VXX to take advantage of projected higher future volatility and to further hedge my portfolio.

$LVS:

As DKI predicted, Golden Week, the Chinese holiday that started at the beginning of October, went extremely well in Macau. Visitation reached 84% of 2019 levels. Occupancy in Macau in early October hit 88% and occupancy on October 1st was at 94%. In addition, there has been a shift in Macau from the low margin VIP business to the higher-margin mass and premium mass market. $LVS has the largest share in the premium mass segment meaning it’s perfectly positioned to take advantage of the new business and could show 2019-level property EBITDA even before gross gaming revenue has fully recovered.

This excellent fundamental news sent the stock up in pre-market trading. $LVS then declined as travel stocks plummeted. This happens every time there is a major war. As I write this, the market has correctly realized that while international travel may be impaired for a while, the Chinese tourists who gamble in Macau will not be affected by war in Israel.

Conclusion:

This is going to be an ongoing situation. The reactions of Egypt, Saudi Arabia, a newly-unified Israeli government, the US, and Iran are all going to affect the outcome. There are additional implications for the Ukraine/Russia conflict as the US runs into difficulty financing and arming two different conflicts at the same time. China is almost-certainly re-evaluating their planned takeover of Taiwan considering the possibility of putting the US in a position to be involved in three different fronts at the same time. DKI will continue to monitor and update you on any aspects of the situation that affects markets. As of now, there are no changes to the portfolio.

 

IR@DeepKnowledgeInvesting.com if you have any questions.

 

Information contained in this report is believed by Deep Knowledge Investing (“DKI”) to be accurate and/or derived from sources which it believes to be reliable; however, such information is presented without warranty of any kind, whether express or implied and DKI makes no representation as to the completeness, timeliness or accuracy of the information contained therein or with regard to the results to be obtained from its use.  The provision of the information contained in the Services shall not be deemed to obligate DKI to provide updated or similar information in the future except to the extent it may be required to do so. 

 

The information we provide is publicly available; our reports are neither an offer nor a solicitation to buy or sell securities. All expressions of opinion are precisely that and are subject to change. DKI, affiliates of DKI or its principal or others associated with DKI may have, take or sell positions in securities of companies about which we write. 

 

Our opinions are not advice that investment in a company’s securities is suitable for any particular investor. Each investor should consult with and rely on his or its own investigation, due diligence and the recommendations of investment professionals whom the investor has engaged for that purpose. 

 

In no event shall DKI be liable for any costs, liabilities, losses, expenses (including, but not limited to, attorneys’ fees), damages of any kind, including direct, indirect, punitive, incidental, special or consequential damages, or for any trading losses arising from or attributable to the use of this repor

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