The intensifying conflict between Israel and Hizbollah has investors nervous, but they say only a broader regional escalation would cause them to sell-out aggressively.
The fighting along the Israeli-Lebanon border has been the main reason for increased selling pressure in global markets, which have also been buffeted this month by North Korea's missile tests and deadly bomb blasts India's financial capital, Mumbai.
However markets, especially emerging markets, recovered some ground on a growing view that the U.S. Federal Reserve might stop raising interest rates soon, stemming the negative impact higher rates have on economic growth.
Reports of 3,000 Israeli reservists being called up ahead of a possible ground offensive into Lebanon is a troubling development to investors, but did not spark a major sell-off.
Most significantly oil prices have fallen back from an all-time high of $78.40 a barrel a week ago, even as the violence has escalated.
"The risk lies not so much in the conflict between Israel and Lebanon. It depends on whether it spreads to oil producing countries," said Kingsmill Bond, emerging markets strategist at Deutsche Bank in London.
"As long as the conflict is contained and does not spread to Iran, we would not be too concerned from an equity market perspective," he added.
Gold, emerging markets seen stable
Other evidence of a more measured response by investors to the rising geopolitical tensions can be found in that gold, whose price generally benefits in times of rising global risk premium, has dropped $42 an ounce in the past week.
Emerging markets, which suffer when investors flee riskier assets, have stabilized and yield spreads over supersafe U.S. Treasuries have narrowed.
Israel's $130 billion economy is not expected to suffer dramatically if the fighting ends soon.
The Israeli shekel fell to a near three month low last week of 4.56 versus the U.S. dollar, but has since recovered to 4.46.
Israeli sovereign Eurobonds have not suffered from any significant sell-off given most of them carry guarantees from the U.S. government. Lebanese Eurobonds are highly illiquid, traded mainly by local investors.
"Stock, oil and gold prices have come off from the highs — indicating a dip in risk aversion after it rose last week. So far markets have taken high oil prices in their stride," said Niels Christensen, senior currency strategist at Societe Generale in Paris.
Citigroup's Global Wealth Management group has not made any changes in its market outlook but warned an outbreak of fighting in oil producing countries could keep oil prices elevated.
"Persistently high oil prices - combined with market uncertainty, both about availability and potential retaliatory moves, especially in Iran - have the clear potential to derail, or at least crimp, the so-far robust and resilient global economic growth," Citigroup's Global Wealth Management team said in a note to clients.
Israel is fighting Hizbollah militants to the north and Palestinian militants to the south after these groups made cross-border attacks and captured Israeli soldiers.
U.S. Secretary of State Condoleeza Rice is scheduled to visit the Middle East starting on Sunday in an effort to reduce the fighting which has killed 344 people in Lebanon and 34 in Israel. "Much is at stake because at this stage Israel is unable to make a cease-fire. A cease-fire would be a kind of capitulation in the sense that it has not been able to achieve any of its declared aims," said Nadim Shehadi, associate fellow at the Royal Institute of International Affairs in London.
Israel is seeking the return of abducted soldiers and the removal of Hizbollah from southern Lebanon.
"There will continue to be tensions in the Middle East, but the likelihood of a major conflict is low and from that point of view it is not affecting our investment strategy," said Geoffrey Blanning, head of emerging market debt and commodities at the Schroders Alternative Investment Group in London.
