The ongoing Middle East conflict, particularly the missile exchanges between Israel and Iran, is increasingly influencing global equity markets. This conflict could evolve into a localized war, similar to the Russia-Ukraine war, where markets gradually adapted to the ongoing geopolitical tensions. Equity markets will remain volatile in the near term, with potential corrections, until Israel’s response to Iran’s missile strike becomes clearer.

Nifty 50 fell nearly 5% in the last 1 week of trading - steepest weekly decline since June 2022 when it fell 5.61%. Similarly, the S&P BSE Sensex fell 4.54%, closing below the 82,000 mark. Real estate bore the brunt of the sell-off with Nifty Realty index falling 8.7% this week. Nifty Financial Services index also posted a significant decline of 6.2%, while the Nifty Auto index dropped 5.7% amid rising concerns over inflationary pressures and higher input costs due to spiking oil prices.

Foreign portfolio investors were also major sellers during this market downturn, pulling out a massive ₹30,613 crore over the last 3 trading sessions. This marks one of the largest FPI outflows in recent memory, with ₹15,243 crore withdrawn on Thursday alone—the largest daily outflow by FPIs in the past 4 years. Analysts point to growing concerns that FPIs may redirect their investments to China, where Beijing has introduced a series of policy measures aimed at reviving its sluggish economy. While China's lower valuations may appear attractive, opinions remain divided. Some analysts argue that India’s growth potential remains a strong pull for foreign investors, while others believe India’s relatively high valuations could deter further investment. So, what exactly is happening to Indian markets? Let’s look at the impact of the rising escalation between Israel and Iran on stock markets, the upcoming US elections, US macroeconomic data and the impact of all this on Indian stocks in the recent term.

One Year After Hamas' Attack: Escalating Israel-Iran War Sparks Market Volatility

Tensions between Israel and Iran are escalating, driving significant market instability, particularly in energy. Israeli airstrikes on a Beirut health center, which resulted in casualties, have heightened geopolitical risks. Israeli Prime Minister Benjamin Netanyahu has vowed retaliation after Iran launched 200 ballistic missiles at Israel, further escalating tensions. Iranian missiles also targeted Tel Aviv, with Israel confirming the deaths of eight soldiers in southern Lebanon.

UN Secretary-General Antonio Guterres has described the situation as "escalation after escalation," adding uncertainty to global markets. This conflict could disrupt oil supplies in the region, potentially driving crude oil prices higher, impacting global energy costs and increasing volatility in the markets.

Rising Tensions Over Iran's Oil Infrastructure

The market is increasingly worried about the possibility that Israel might target Iran’s oil infrastructure in retaliation for Iran's missile attack earlier this week. When asked whether the U.S. would support such a strike, President Joe Biden hinted that discussions were ongoing but downplayed any immediate action. The Pentagon also confirmed ongoing talks with Israeli officials about their response to Iran, without providing further details.

Iran produces about 3.2 million barrels of oil per day, roughly 3% of global output. Any disruption to Iranian oil flows could have significant consequences for global energy markets. Until now, the risk to supply had been minimized due to the lack of actual disruptions. However, further escalation could be a game changer. Some market analysts are already adjusting their oil price forecasts in light of the escalating tensions.

Iran’s Missile Strike: Escalation or One-Off Event?

There is still uncertainty around whether Iran’s missile strike is the start of a prolonged escalation or just a one-off response. Investors are waiting to see how Israel will respond, knowing that a full-blown retaliation could lead to further volatility in the markets. A similar event occurred in April when Iran's missile attack on Israel was successfully intercepted with US assistance, which prevented significant market disruptions. However, the potential for further conflict could weigh on risk-sensitive assets like equities.

Gold and the dollar remain safe-haven assets during times of geopolitical tension, similar to the market's reaction during Russia's invasion of Ukraine in 2022. Such events have historically led to short-term market fluctuations, with investors moving away from risky assets in favor of gold and the US dollar.

Global Crude Oil Prices Rise Amid Middle East Tensions

Despite the deepening conflict, global markets have largely remained steady, with oil prices—historically sensitive to Middle East unrest—rising by about 8% this week. However, soft global demand and ample oil supply have kept these price increases in check for now. But this could change if the conflict escalates further, particularly if Israel opts to target Iran's oil infrastructure, a scenario U.S. President Joe Biden has confirmed is under discussion.

Since the Iran and Israel escalation, crude oil prices have jumped over 5% in the past 2 days and rose 3% on Wednesday alone, fueled by escalating tensions in the Middle East. Iran’s direct missile attacks on Israel, the largest ever, growing involvement of Hezbollah in the conflict and Israel’s potential retaliation, particularly targeting Iranian oil infrastructure, have spurred fears of supply disruptions. With no signs of de-escalation, oil prices are expected to remain elevated in the near term.

Despite these tensions, fears of immediate oil shortages have been tempered by several factors. U.S. crude inventories rose by 3.9 million barrels last week, according to the Energy Information Administration (EIA), exceeding expectations of a decline. This increase suggests that the market is currently well-supplied and could withstand potential disruptions.

OPEC has confirmed plans to increase their output in December to 180,000 barrels per day, which could alleviate some pressure on global oil supply. According to analysts, OPEC’s capacity could help mitigate the impact of a complete loss of Iranian oil. The lifting of force majeure in Libya, which had restricted oil production, also adds to the sense that global supplies remain robust for now.

Brent crude oil prices have rallied around 4% since Iran’s attack on Tuesday, pushing up costs across various industries. Oil-linked sectors, including oil marketing, paints, aviation, and tyre companies, have seen a sell-off as investors anticipate rising input costs. However, analysts see the rise as relatively insignificant, given the ongoing geopolitical involvement of major oil-producing nations.

Upcoming US Elections and Major Economic Data Remains in Focus

Investors are also eyeing the upcoming US election and a crucial jobs report, both of which could have significant implications for the Federal Reserve’s monetary policy.

US Elections

With the US election race tightening , investors are seeking to profit from anticipated market volatility using complex derivatives strategies. Currently, the options markets are pricing in a 2.8% swing for the S&P 500 index on November 6, the day after the election, according to UBS analysis. This figure has steadily increased over the past month and could continue to rise as election day nears, indicating growing expectations of turbulence. Market participants are not necessarily betting on the victory of a specific candidate, but rather on the overall volatility that typically accompanies such a high-stakes event.

This growing interest in volatility is driven by the close nature of the race, increasing the possibility of a disputed result, similar to what occurred in 2020. Many investors believe current implied volatility is still underpriced, suggesting room for further increases. Historically, volatility spikes around election time. The S&P 500 rose 2% the day after the 2020 election, and 1.1% after the 2016 election, highlighting how large moves are possible. Given the tight race, some investors see betting on market volatility as a safer option than trying to predict which specific stocks or sectors will benefit from a Trump or Harris victory.

US Jobs Report Shows Gains: Fed To Cut Interest Rate At Slower Pace

US labor market showed remarkable strength in September, with nonfarm payrolls rising by 254,000 jobs, the highest in six months. This jump in job creation, coupled with a drop in the unemployment rate to 4.1%, indicates the U.S. economy remains resilient. Additionally, job gains in July and August were revised upward by 72,000, further supporting the view of a robust labor market. This development likely reduces the need for aggressive interest rate cuts from the Federal Reserve for the remainder of 2024.

The strong employment data has prompted market participants to reassess their expectations regarding Federal Reserve policy. Fed Chair Jerome Powell had already signaled earlier in the week that the central bank is not in a rush to lower rates further. The September report strengthens this stance, reducing the likelihood of another 50-basis-point cut in November.

Prior to the Jobs Report, CME’s FedWatch Tool showed a 38% probability of the Federal Reserve cutting interest rates by 50 basis points in November, a decrease from 58% just a week ago. Post the US Jobs Report the odds of a quarter-percentage-point rate reduction in November surged to 95% after the report. The Fed, which has been combating inflation for much of the past year, is keen to avoid loosening policy too quickly and seeing a resurgence in price pressures. Powell has also indicated that the U.S. central bank is likely to stick to 0.25% rate cuts in the near term instead of the 0.50% rate cuts going forward.

Ports Reopen in the U.S., Easing Supply Chain Concerns

In positive economic news, U.S. East Coast and Gulf Coast ports began reopening on Thursday night after a wage agreement was reached, ending the industry's biggest work stoppage in nearly 50 years.

The resolution of the port strike removes a significant supply chain bottleneck, alleviating concerns over delays in goods movement, which could have further strained inflationary pressures in the U.S.

Chinese Stock Markets Rise on Stimulus Measures Sucking Money From Emerging Countries

Chinese equities recorded their strongest week since 2008, with the CSI 300 index rising 15.7%, after Beijing introduced a $114 billion stimulus package aimed at stabilizing markets and boosting consumption. The People's Bank of China created an Rmb800bn ($114bn) lending pool to support stock buybacks and local equity investments, driving gains in both Chinese and Hong Kong markets.

This rally also lifted European stocks, particularly luxury and industrial metal sectors. Copper prices surged over 5% and iron ore rebounded after recent lows, reflecting strong demand from China’s manufacturing sector.

Importance of global easing conditions, emphasizing the positive impact on China’s economy. Meanwhile, China’s use of leveraged investment in the stock market could sustain the rally further. Commodity prices, especially copper and iron ore, benefited significantly from the stimulus measures, though oil lagged due to Saudi Arabia's plans to increase output.

Read our detailed analysis of the China stock market stimulus that sparked the rally.

Indian Energy Dependence Continues on Middle East

India has been diversifying its oil imports, particularly from Russia. However, Middle Eastern countries such as Iraq, Saudi Arabia, the UAE, and Kuwait still account for a substantial share of India's oil imports. In August 2024, about 44.6% of India's crude imports came from the Middle East, up from 40.3% in July, despite increased imports from Russia. Additionally, India relies heavily on Qatar for LNG, with nearly half of its LNG imports sourced from the Gulf state via the Strait of Hormuz and around 2/3rds of oil from the same route.

If the Strait of Hormuz, the world’s most important oil transit chokepoint, is blocked or disrupted due to conflict, India’s energy imports would be severely affected. Shipments would need to be rerouted via longer routes, such as the Cape of Good Hope, leading to supply delays and higher transportation costs. This, in turn, could push oil and gas prices even higher, exacerbating inflation and disrupting economic growth.

Economic Impact of Higher Oil Prices

Higher oil prices will have direct consequences for India's economy, particularly by fueling inflation, which has recently shown signs of easing. According to a Morgan Stanley report, a $10 per barrel increase in crude prices can raise India’s Consumer Price Index (CPI) by up to 0.5 percentage points. A sustained spike in oil prices would also hinder the RBI’s ability to lower interest rates, which were widely anticipated by the end of the year.

The government’s fiscal deficit could also come under pressure. India subsidizes fuel to a significant extent, and a sharp increase in oil prices may force the government to cut back on spending in other critical areas, such as infrastructure development. Additionally, the widening of the current account deficit due to higher import bills would further strain the economy. ICRA estimates that a $10 per barrel rise in crude prices could increase India’s net oil imports by $12-13 billion, widening the CAD by 0.3% of GDP.

Potential Strain on Oil Marketing Companies (OMCs)

Indian oil marketing companies have benefited from lower crude prices in recent months, leading to expectations of fuel price cuts for consumers. However, any escalation in the Iran-Israel conflict would eliminate the possibility of price cuts and may even force OMCs to raise fuel prices to protect margins. With oil prices on the rise, OMCs could face reduced profit margins, which would further pressure India’s economy.

Indian Companies With Exposure to Israel

At least 14 Indian companies have significant ties to Israel & the fallout from the Israel-Iran war, with varying levels of exposure to the conflict.

1. Adani Ports, a key player in this context, owns the Haifa Port in Israel. Its shares dropped by as much as 2.5% to a day’s low of Rs 1,429.35 on the Bombay Stock Exchange (BSE). Despite the uncertainty, the immediate impact on its operations in Israel could be limited unless the conflict disrupts trade routes or port operations.

2. Sun Pharmaceutical, India’s largest drugmaker, holds a majority stake in Israel’s Taro Pharmaceutical. While its stock remained relatively flat, concerns linger over the potential operational disruptions.

3. Other pharmaceutical companies, like Dr. Reddy’s and Lupin, are also being watched closely due to their ties with Tel Aviv-based Teva Pharmaceutical, a major player in the global generic drugs market.

4. Indian IT majors like Tata Consultancy Services (TCS), Wipro, Tech Mahindra, and Infosys all have operations in Israel, providing critical services to various industries. Though their operations are not immediately impacted, the ongoing conflict adds an element of risk, keeping investors cautious.

5. In the financial sector, the State Bank of India (SBI), with its global footprint, has connections in Israel. However, SBI’s strong domestic presence may allow it to navigate any short-term disruptions more effectively than other firms with larger dependencies on the region.

6. Stocks of companies like Asian Paints and Berger Paints, both of which use crude oil in production, fell by 3-4%.

7. Similarly, tyre manufacturers such as Apollo Tyres, MRF, and JK Tyre saw declines between 2-4%.

SEBI Tightens F&O Regulations to Curb Speculation

A SEBI study revealed that individual traders in the derivatives market faced cumulative losses of ₹1.8 lakh crore over the past three years , with ₹750 billion lost in FY24 alone. Even experienced traders incurred significant losses in the F&O segment. The report highlights a 13-fold increase in index option trading on the NSE, reaching ₹138 trillion in FY24 from ₹10.8 trillion in FY20. SEBI F&O report expressed concerns about household savings being diverted to speculative trading rather than productive investments.

In a move to reduce this speculative trading SEBI has introduced new rules that could decrease trading volumes by 30-40%. These rules aim to curb excessive retail participation in index derivatives, where daily turnover frequently surpasses Rs 500 trillion, often resulting in significant losses for small investors.

Key changes include increasing the contract size from Rs 5 lakh to Rs 15 lakh, which raises margin requirements. SEBI also mandated the upfront collection of option premiums and limited weekly expiries to one benchmark per exchange. Intraday monitoring of position limits and the removal of calendar spread treatment on expiry days are also part of SEBI's plan. These rules are expected to raise the entry barrier for retail investors, discouraging speculative trades.

Are Indian Stock Markets Under Pressure?

A full-scale war in the Middle East would be detrimental to India’s energy security, pushing oil prices higher and destabilizing global markets. India's net oil import bill could rise significantly, potentially reaching $101-104 billion in the current fiscal year, up from $96.1 billion in 2023-24. The value of imports would increase further if the conflict intensifies, with a $10/barrel increase in crude prices potentially adding $12-13 billion to the import bill.

This Israel & Iran war triggered market correction presents an opportunity for long term investors to enter quality large cap stocks, particularly in the pharmaceutical and FMCG sectors, which currently offer valuation comfort. India’s rupee could also face depreciation as a result of higher oil prices, further inflating import costs and widening the current account deficit. A weak rupee, combined with rising energy prices, could create a challenging macroeconomic environment, forcing the government and RBI to navigate inflationary pressures and fiscal constraints.

Read other related articles on the Middle East conflict

1. Impact of War on Stock Markets: Israel-Palestine War & Impact on Indian Stock Markets
2. Iran-Israel Conflict: How It Impact on India's Share Market?