Middle East tensions push oil above $85, but equities show resilience on Trump's TACO trade

Mumbai: Fresh tensions in the Middle East have pushed oil prices above $85 a barrel, but they have failed to trigger the kind of panic selling in equities that typically accompanies geopolitical shocks. Instead, investors are betting that Donald Trump will once again stop short of allowing the conflict to spiral, keeping faith with Wall Street's so-called TACO (Trump Always Chickens Out) trade.

Indian equities declined on Tuesday after Trump's latest salvo over the Strait of Hormuz, but downsides were relatively moderate, with the risk aversion far more tempered so far compared to the previous bout of conflict, signalling investors and traders, for now, are less worried about the renewed conflict spiralling into a crisis.

The Sensex and Nifty ended 0.7% lower on Tuesday, while the Nifty Mid-cap 150 and Small-cap 250 dropped 0.5% and 1%, respectively.

"The resilience is because investors are not pricing in a full-blown war in the Middle East," said S Naren, chief investment officer, ICICI Prudential AMC. "Moreover, markets also appear to be getting accustomed to intermittent geopolitical tensions in the region."

Geopolitical flare-ups of this magnitude typically trigger market reversals. Yet, despite the latest escalation between the US and Iran, the Nifty's fall has been restricted to around 1.4% in the past week. The Mid-Cap index is up 0.6%, and the Small-Cap index is up 0.6% in this period.

These price moves suggest caution at best, rather than outright panic. That's because, for now, the market is bullish on the TACO trade-Wall Street shorthand for 'Trump Always Chickens Out', referring to the US President's tendency to reverse or soften his policy threats. "Investors are expecting another TACO behaviour and, at this point of time, are not discounting any escalation because Trump is known to move unexpectedly," said Nilesh Shah, managing director, Kotak Mutual Fund. "In the case of India, market outlook is more tied to oil prices than the missiles fired in the Middle East, which in turn seems to be tracking TACO trade."

Oil prices, which have taken the renewed military exchanges between the US and Iran in the past week in their stride so far, broke above the $80 per barrel-mark to a one-month high on Tuesday in response to the US blockade of Iran's oil exports. Brent prices were up 3.8% at $86.5 a barrel. Higher oil prices are negative for India, but investors are not bolting for the exits just yet as few expect stocks to test their March lows. Instead, expectations are growing that those who can look past the sharp swings in the near term could be rewarded over the next 12 months after the two-year dry patch in the market.