US Stock Market Declines After Iran Launches Drone Attack on Israel

The US stock market experienced a significant decline on Friday, with the Dow Jones Industrial Average falling for a fifth straight day. The market's decline was the largest weekly decline since March 10, 2023, and was attributed to investor concerns about potential escalation of tensions between Iran and Israel. The market's reaction to Iran's first-ever, full-scale military assault on Israel will come on Sunday evening, when futures trading opens in the US for stocks, bonds, commodities, and currencies.

Cryptocurrency Prices Fall After Iran Launches Drone Attack on Israel

Cryptocurrency prices fell Saturday evening after Iran launched a wave of drones at Israel, marking an early indication of the turmoil that could hit markets as investors start to price in the threat of a broader Middle East war. Bitcoin was down 5% from its price on Friday, while ether sank more than 7%, and XRP tumbled 13.5%, according to CoinMarketCap.

Wall Street's Reaction to Iran's Attack on Israel

Reports at the time said an Iranian attack on Israel was expected within two days, boosting US benchmark oil prices as much as 3% to top $87 a barrel. US Treasury bonds also rallied sharply, sending the 10-year yield down as much as 10 basis points as investors looked for safety. Similarly, the US dollar advanced as the geopolitical tensions caused investors to turn away from riskier emerging-market currencies. Even the euro fell to a five-month low against the greenback, as markets also weighed the prospect of the European Central Bank cutting rates before the Federal Reserve does.

Market Correction or Consolidation?

Investors are taking profits after the S&P 500's 10.2% first-quarter jump, largely due to concerns about the timing of interest rate cuts after an uncomfortably high inflation reading. Leading strategists aren't shocked by the pullback — they're just surprised it took this long. The market's overdue for a correction — or at least a consolidation," said Anthony Saglimbene, the chief market strategist at Ameriprise Financial, in a recent interview with Business Insider. "I think this might be the excuse that investors use to maybe see a normal correction: 5%, 10%." From late October through March, the S&P 500 enjoyed a virtually uninterrupted 27.6% rally based on better-than-expected earnings and economic data. It's only natural that US stocks take a breather before mounting further gains."We can't expect this thing to grow to the sky," said Rick Pitcairn, the chief global strategist at the eponymous wealth management firm Pitcairn. "There's going to be some pullbacks — there should be some pullbacks. And investors should be more expectant of those — and they should be fearful of those — because that's the dynamic of any healthy market."

Valuations are Troubling but Not Yet Terrible

Some pundits argue that this market is far from healthy, at least from a valuation standpoint. The S&P 500's forward price-to-earnings (P/E) ratio is historically rich at nearly 21x. And while it's still well below the dot-com bubble levels, it's still too close for comfort for many investors. The S&P 500's forward P/E ratio is stretched relative to its history and other indexes, largely due to mega-cap growth companies that have driven the bulk of its gains in the last 12 months. "We are at a setup where these numbers of extremes — whether it's in sectors or factors or styles compared to the episode we saw during the dot-com — basically, we've never seen this many extremes," said Raheel Siddiqui, a senior investment strategist at Neuberger Berman. Siddiqui added: "I see a very similar setup. I'm not saying we are going to get into a dot-com bubble — I'm just saying that the distortions are as extreme, or dislocations are as extreme, as they were."

The chorus of concerns about where stocks are trading has grown louder lately — especially for the mega-cap companies that have long carried the S&P 500. In recent weeks, market veterans like Jon Wolfenbarger, strategy chief Albert Edwards, and leading fund manager Bill Smead have called for massive market crashes, warned of froth, or drawn parallels to the tech bubble. And gains have largely been powered by multiple expansion instead of profit growth," said James Ragan, the director of wealth management research at DA Davidson. So, if high inflation keeps interest rates higher for longer, investors may rethink the premium they're willing to pay. Ragan said that more multiple expansion seems improbable in this backdrop, which puts pressure on companies to deliver during the Q1 earnings season. But even if profits top estimates again, there are other risks, including the effect an inflation resurgence could have on the economy."Those higher rates are starting to push back on elevated valuations for stocks right now," Saglimbene said. "And so I think this earnings season is going to be very important because the macro backdrop is starting to push back on this idea of a painless soft landing, which I think is ultimately priced into stocks right now."

There's about a one-in-three chance that the US enters a recession this year, Saglimbene said, though his base case is that economic growth and earnings will hold up. This market backdrop isn't perfect, but there are still plenty of reasons to stay invested in stocks."Inflation is high, but the economy is growing above its long-term growth potential; unemployment is at or near multi-decade lows — that's a really good setup for growth in the economy and corporate profits," Saglimbene said. Indrani De, the head of global investment research at FTSE Russell, seconded that optimism. Earnings and income data affect each other, so she's encouraged that both seem to be robust."It's a good sign that what the corporate earnings expectations are and what's coming in from the national accounts are in line — that growth has been positive," De said. She added: "Those two lining up directionally is something to be noted and lends confidence to numbers."

Even market skeptics like Siddiqui say that while US stocks may be very richly valued, there are still plenty of attractive investing opportunities for those who look in the right places. In fact, the strategist noted that the dot-com bubble was an especially fruitful time for active managers."Everybody was going nuts about technology," Siddiqui said. "If a thoughtful manager went the other direction against these things — as tough as it was — you could have added enormous value in the ensuing months and quarters and years."

Although technology stocks may not tumble to the extent they did a few decades ago, Siddiqui is confident there will be a similar shift in market leadership. Investors should prepare by diversifying away from tech and communication services stocks and into defensive sectors like consumer staples, healthcare, and utilities, Siddiqui said, which are starting to perform better relatively after being out of favor. Cyclicals in energy, industrials, and materials are also enticing as the global industrial production cycle picks up."It's very strange that I am positive on traditional cyclicals and defensives at the same time, but it's the two of them versus tech," Siddiqui said.