Morning Wrap: ASX 200 to extend gains + Defence, Gold and Energy stocks rise on Israel conflict

S&P 500 finished near best levels despite opening in negative territory, energy stocks rallied amid a spike in oil prices, defence stocks surge on the escalation of the Israel-Hamas conflict, demand for safe-havens sends gold prices higher plus Morgan Stanley's quant stock picks.

Let's dive in.

S&P 500 SESSION CHART

S&P 500 higher and finished near best levels overnight (Source: TradingView)

MARKETS

• S&P 500 finished higher and near best levels after a -0.45% open

• US 10-year yield hits a 1-week low after falling 17 bps to 4.64%

• Safe-haven demand is boosting gold prices, up 2.2% in the last two sessions

• WTI crude jumps amid geopolitical uncertainty, sharp 8.8% fall last week

• Stocks and treasuries lose inverse correlation, most positive since 2005 (Bloomberg)

• US stocks threatened by profit warnings as spending fades (Bloomberg)

• Hedge funds sell US energy stocks at accelerated pace in the week ending 6-Oct, says Goldman Sachs (Reuters)

• European luxury stocks post biggest quarterly drop since 2020 (Reuters)

• Hamas attack raises fears of Middle East oil supply disruption (Bloomberg)

• Bullish oil options surge the most since Russia invaded Ukraine (Bloomberg)

• Israel conflict could have long-term impact on oil prices, Citi says (Bloomberg)

STOCKS

• Oil and defence stocks rally on escalation of the Israel-Hamas conflict (Reuters)

• Trian boosts Disney stake to $2.5B, revives board seat push (FT)

• Bristol-Myers Squibb to buy Mirati Therapeutics for up to US$5.8bn (CNBC)

• Citigroup to sell China wealth arm to HSBC (Reuters)

• Tesla’s China-made EV sales volume falls 10% year-on-year (Reuters)

EARNINGS

• Third quarter earnings season will kick off this week

• S&P 500 earnings expected to decline 0.3% year-on-year in Q3, up from the 4.1% decline in the previous quarter

• Marks a fourth-straight quarter of year-on-year earnings declines

• Analysts expect 12.2% earnings growth for 2024, citing factors such as resilient industrial production, upbeat consumer economic data and the Fed pause

ISRAEL-HAMAS

• Death toll in conflict tops 1,100; Israel regains control outside Gaza (Bloomberg)

• Hamas open to truce talks with Israel (Reuters)

• Israeli PM Netanyahu faces demands for ground offensive in Gaza (FT)

• Iran denies helping Hamas plan attack on Israel (Telegraph)

• Israeli-Saudi Arabia negotiations may be delayed as priorities shift (Bloomberg)

• US to send multiple military ships and aircraft closer to Israel (Reuters)

CHINA

• China tourism revenue recovers but below pre-pandemic levels (Reuters)

• Country Garden seeks debt deal, Evergrande creditors expect liquidation (Reuters)

• China home sales fall during Golden Week holiday (Bloomberg)

• Global investors still shun Chinese stocks despite better data (Nikkei)

ECONOMY

• Middle East conflict adds new risks to global economic outlook (Reuters)

• German industrial production slightly weaker than forecast (Bloomberg)

• Eurozone Sentix investor sentiment steadies in October (Reuters)

Sectors to Watch: Defense, Gold and Energy

Major US benchmarks managed to move higher despite the start of a potential war. That's some fairly admirable strength. Stocks that were poised to benefit from the conflict led to the upside overnight, including:

• Defense: The iShares US Aerospace and Defense ETF rallied 4.45% overnight (its still down around 6% since the Russian invasion of Ukraine. A BofA note flagged that the Israel-Hamas war places pressure on US weapon stockpiles and may drive up Department of Defence investments. Unfortunately for the ASX, there's not a whole lot of companies that have direct exposure to this space. Some key names include Austral, Codan, Droneshield, Electro Optic Systems and Xtek.

• Gold: Classic flows into safe-haven assets (as well as a bounce from extreme oversold levels) is bringing life back into the yellow metal. The VanEck Gold Miners ETF rose another 2.4% overnight and up 6.3% in the last three sessions. Most local names rallied 4-6% on Monday, so let's see if they extend their gains on Tuesday.

• Energy: Oil prices rallied 4.4% overnight but it's mostly risk premium, not fundamentals, says ING Economics, adding that if Iran's involvement is confirmed, expect a tougher stance and tighter oil supply. Like gold, let's see if more positive flow follows through for local energy names (not just oil but also coal).

Data Vacuum Ends with a Bang

For the last couple of weeks, bond yields have climbed and stocks have dropped sharply in spite of no data releases or obvious catalysts. But that's ended with one almighty bang. First, the US payrolls report which stunned even the most optimistic of forecasts. The US jobs report is notoriously hard to forecast, especially when the response rate to the US Bureau of Labor Statistics' survey is now down to 41%(!). It also explains why there is such a massive disparity between the official unemployment report and the ADP report which is released two days earlier and used to be a good cue for the government number.

Source: Bloomberg

Then, over the weekend, renewed geopolitical tensions in the Middle East which have sent the oil price higher and stocks in the Middle East lower.

This week, it's all eyes on inflation with US CPI and PPI out this week. All being well, the US consumer inflation print will dip below 4%, putting the Federal Reserve one step closer to a soft(ish) landing. But oil prices may have something to say about that - especially on the headline number. We should also get Chinese inflation data this week. The rest of the economic calendar is dominated by central bank speak - including the RBA's head of financial markets Christopher Kent who is speaking at the Bloomberg Address in Sydney this Wednesday. Our own Sara Allen will be at the event, hoping to get a question in!

Morgan Stanley's Quant Stock Picks

The quant investing team at Morgan Stanley have updated their favoured and unfavoured stocks in this environment. The immediate thing which stands out is that most banks are in the unfavoured list - except one - ANZ (ASX: ANZ). The Shayne Elliott-led bank was upgraded two weeks ago to Overweight from equal weight by the team's banking analyst.

Also on the favoured list:

• Iron ore play Deterra Royalties (ASX: DRR) 

• Property plays REA Group (ASX: REA) and Stockland (ASX: SGP).

Moving out of the favoured list (but not entirely unfavoured) are: 

• The Lottery Corporation (ASX: TLC)

• South32 (ASX: S32)

• Orica (ASX: ORI)

• Qantas (ASX: QAN).

On the unfavoured list:

• Major banks like CBA (ASX: CBA), Westpac (ASX: WBC), and the Bank of Queensland (ASX: BOQ) dominate the list.

• The other financials name new to the list is the ASX itself ASX (ASX: ASX)

And before you ask, here's how Morgan Stanley rate their own stock-picking efforts:

"Prior to the changes we made in the note, our most-preferred stock ideas cohort exhibited a 50% hit rate on an absolute and relative return basis since inclusion. Whilst the performance across this cohort has been mixed, the standouts include APE (+52.3%), WHC (+41.7%) and ALU (+25.2%) have performed the best on a relative (vs. ASX 200) basis since inception. What has worked includes the relative underperformance of QAN, S32 and SCG."

ASX corporate actions occurring today:

• Trading ex-div: Reece (REH) – $0.17, Turners Automotive (TRA) – $0.055

• Dividends paid: Chorus (RNU) – $0.19

• Listing: None 

Economic calendar (AEST):

• 9:30 am: Australia Consumer Confidence

• 10:30 am: Australia Business Confidence