Traders ignore defensive stocks against risks in the Middle East. What's driving them

Investors in the U.S. stock market are in no hurry to seek refuge in defensive assets, despite the escalation of geopolitical tensions, according to Bloomberg. This increases the risk that they will be caught off guard if the conflict between Israel and Iran takes an unexpected turn. What is driving market participants and should they start worrying?

Investors in the U.S. stock market are in no hurry to retire to «safe havens» even amid rising geopolitical tensions, reports Bloomberg. US President Donald Trump is considering military support for Israel in its conflict with Iran: such a move could spike oil prices and increase inflation risks. In a normal situation, this would already be enough for wealth managers to start shifting into defensive assets. However, last week traders only to a limited extent reallocated funds into defensive sectors such as utilities, consumer staples and healthcare, the agency writes. The only exception was active buying of shares of energy companies, which behave as defensive assets during periods of unstable oil supplies.

Far from shifting into defensive assets, investors have continued to buy U.S. stocks, with the S&P 500 Index now only a few percent below its record high. The share of defensive sectors in it - measured by their combined weighting - is at its lowest level in 35 years, Strategas analyst Todd Sohn emphasized in a Bloomberg presentation. Moreover, Goldman Sachs' Paired Trades Index, which reflects a strategy of buying cyclical stocks and selling defensive ones, has shown gains since the Israel-Iran conflict escalated - in contrast to a drop in April, when Trump announced sweeping duties.

All this increases the risk for market participants to be caught off guard if the situation in the Middle East takes an unexpected turn in the coming days, according to Bloomberg.

Investors have good reasons not to rush into protective assets amid geopolitical unrest, the agency writes. For example, according to UBS, the impact of such events on stock markets is usually short-lived. During the last 11 major geopolitical events, the S&P 500 index was on average only 0.3% lower a week after the event, and 12 months later it was 7.7% higher.

Citi strategists, led by Dirk Wheeler, also noted that markets tend to quickly play down geopolitical risks unless there is a sharp and sustained rise in oil prices. The bank predicts that Brent crude will trade in the $70-80 per barrel range: a surge in raw material costs will have only a temporary impact on risk assets. Since the worst-case scenarios have been avoided so far, Citi remains positive on U.S. equities.

Hedge funds are still taking cautious positions, notes Christopher Murphy, co-head of derivatives strategies at Susquehanna, in a Bloomberg statement. According to him, institutional investors were not particularly active in the recent market growth, so now they have no reason to dramatically change strategy because of geopolitical risks. Even on the day of the strikes on Iran, there was no surge of panic in the markets - participants were adjusting positions rather than exiting assets. «Investors are still hedging carefully, but in general they are maintaining risk-adjusted participation in the market rather than panicking,» he emphasized.

Some market professionals are beginning to recommend that investors make more decisive moves toward defensive assets, Bloomberg notes. «The war may or may not get worse, but with the upside potential for equities limited due to inflated valuations, investors should be more cautious,» said Matt Maley, chief market strategist at Miller Tabak + Co. He emphasized that the current situation looks worrying: high uncertainty makes investors particularly vulnerable.

Investment institute Wells Fargo also advises traders to increase the share of protective securities against the background of continuing uncertainty around the duties, which, according to their estimates, will last until the end of the year, reports Bloomberg. In particular, analysts single out the utilities sector as the most stable: these companies mainly operate in the domestic market and therefore are less exposed to foreign trade risks. In addition, they can benefit from infrastructure investments in artificial intelligence. According to Wells Fargo, the sector also looks attractive from a value perspective: the S&P 500 Utilities Index is currently trading at a forward P/E (price/earnings per share) multiple of 17, compared to 22 for the S&P 500 Index.