Somewhere deep down, investors harbor hope that the Middle East conflict will end soon

The market did not like what it heard from Donald Trump. Investors had expected the White House to provide a clear timeline for an end to the Middle East conflict — a statement that the Strait of Hormuz would soon be reopened and the roughly 10 million b/d of lost supply would return. Instead, threats to send Iran "back to the Stone Age" followed. As a result, the S&P 500 plunged and only recovered after news of an Iran-Oman agreement on tanker transit.

The armed conflict in the Middle East has now lasted nearly five weeks, and investors are reacting to Donald Trump's speeches more than to macro data or corporate reports. The president's claim that the war would end in 2-3 weeks inspired the S&P 500 to rally. The index is likely to record its first green week after five straight red ones.

Weekly S&P 500 performance

While the US is a net exporter of energy products, which should support the economy in the short term, supply disruptions will accelerate inflation, slow domestic demand and GDP, and could ultimately lead to a recession.

The situation in Europe is even worse. Not only does the region import oil and gas, but the ECB is preparing multiple interest rate hikes. Tightening will push the currency bloc into contraction well before the US economy. No wonder German bond volatility is surging, and European equity indices are plunging.

Volatility dynamics: German bonds and EuroStoxx 600

The rout in European equities is keeping investors from fleeing US stocks. They also cling to the hope that the Middle East conflict will end soon. Sitting on edge, they do not want to miss a post-war rally — memories are fresh of the S&P 500 rebound after the White House introduced large tariffs on Liberation Day of America.

Thus, the broad index rises on hope and falls on facts. Iran continues to control the Strait of Hormuz, oil is rising, and Trump's threats do not intimidate Tehran. The Middle East conflict risks dragging on. If so, the US economy should brace for a recession.

A slowdown in US economic growth is already showing up in corporate results. Tesla shares fell by more than 5% after reporting lower deliveries than Wall Street expected.

Technically, the S&P 500 retraced from a doji bar and returned to fair value at 6,590 on the daily chart. A fierce battle is underway at that level. A bull victory and a subsequent breakout above the local high of 6,610 would justify resuming long positions toward 6,665 and 6,700. Conversely, a bear victory with a drop to 6,555 and below would provide grounds for selling.