The Stock Market’s Fear Gauge Is Up. It’s a ‘Warning Shot.’

Tensions in the Middle East, sadly, are nothing new. And while investors worried about the conflict between Iran and Israel should prepare for more market choppiness ahead, some analysts argue this isn’t a reason to bail on stocks just yet.

There could be opportunities from any further pullbacks, especially in certain sectors—for investors willing to take the risk.

The S&P 500 has fallen for three straight trading days, bringing its decline this month to nearly 4% through Tuesday’s close. The Nasdaq Composite has dropped around 3% in April, while the Dow Jones Industrial Average has slid about 5%. Meanwhile, the main gauge of volatility in the S&P 500 has crept higher over the past week.

The recent selloff is partly due to rising oil prices this year, because of concerns about the geopolitical landscape. But there is plenty more to make investors skittish: higher-than-expected inflation readings, spiking long-term bond yields, and JPMorgan Chase CEO Jamie Dimon’s uninspiring comments about the economy last week.

This Mr. Toad’s Wild Ride type of craziness for the market shows that stocks are likely to remain on a bumpy path for the foreseeable future.

“Our sense is that volatility is likely to pick up and equity markets are likely to face some near-term downward pressure,” said Chris Senyek, chief investment strategist at Wolfe Research, in a report Monday. Senyek cited “rapidly rising geopolitical risks” as one of the major concerns.

The good news though? Senyek doesn’t think that stocks are due for a prolonged pullback. In fact, some analysts and investment managers see a few sectors where stocks still have good reasons to climb.

“While upside surprises may be somewhat smaller than they’ve recently been, our sense is that 1Q results and guidance will be supportive of further equity market gains—especially, if the biggest stocks leveraged to the AI [artificial intelligence] trade blow past expectations once again.”

Senyek recommends investors look to analog semiconductor stocks as a way to play that possibility. Wolfe’s chip analysts upgraded shares of Analog Devices, NXP Semiconductors, and Microchip Technology earlier this year, citing a rebound in earnings.

Others predict that artificial intelligence demand is likely to remain robust, regardless of what happens in the Middle East or on the inflation front.

Emily Bowersock Hill, CEO and founding partner of Bowersock Capital Partners, a financial planning firm with just under $1 billion in assets under management, told Barron’s that Corning, Honeywell and Rockwell Automation are “stocks that are highly levered to artificial intelligence, but that are generally unloved by the market as of now.”

All three stocks have lagged behind the S&P 500’s gains this year and over the past 12 months.

Energy stocks could also be compelling opportunities in light of oil price fluctuations. Crude prices currently are hovering around $85 a barrel, up nearly 20% this year. Senyek said investors should look at energy services stocks. Wolfe’s oil analysts have Outperform ratings, the equivalent of Buy, on Halliburton, Phillips 66, and Marathon Petroleum.

Irene Tunkel, chief U.S. equity strategist of BCA Research, agreed that oil stocks are attractive now, largely due to expectations that crude prices could rise further if investors worry about potential supply disruptions in the Middle East.

“Energy is a great inflation and geopolitical hedge,” Tunkel told Barron’s. “The market cares about this conflict because of the price of oil.”

Tunkel added that defense stocks, which have lagged behind due to Boeing’s woes, and cybersecurity companies could benefit from further turmoil.

Still, even though market volatility has increased lately, it is still relatively low by historical standards. The VIX, Wall Street’s so-called fear gauge, remains below 20. Its 52-week high is around 35—and the VIX surged above 85 at the start of the Covid-19 pandemic four years ago.

“This is not a time to panic,” said JJ Kinahan, CEO of IG North America, an online trading firm that owns retail brokerage tastytrade. But this is a “warning shot” because the “interest-rate picture remains unclear.”

That said, Kinahan is hopeful the market will hold up reasonably well for the rest of this week and next, when more companies are set to report earnings. He said a “sideways” period for stocks “would be a victory” given the recent volatility.

And of course, some investors say now isn’t the time to try to be a hero and take huge risks. A stable and steady portfolio of blue chip companies should hold up well—even when there are troubling headlines around the world.

“Geopolitics has transformed from a simmering concern to a significant risk for investors and companies alike,” said Joe Salmond, portfolio manager with Thornburg Investment Management, in a report. That’s all the more reason for investors to make sure their holdings are diversified.

“One rarely wants to put all their eggs into one basket, but it is particularly ill-advised when that basket is wobbling precariously,” Salmond added. “And when more things could potentially go wrong, as we think is the case now, diversification is more critical than ever.”

Write to Paul R. La Monica at [email protected]