By William Watts
Published: Jan 4, 2020 9:00 am ET
Markets likely to remain volatile amid expectations for intensifying Middle East conflict
Iranians hold anti-U.S. banners during a demonstration in Tehran on Friday, following the killing of Iranian Revolutionary Guard Major General Qasem Soleimani in a U.S. strike on his convoy at Baghdad International Airport.
Consider it a wake-up call.
Stock market investors shouldn’t panic, but intensifying U.S.-Iran tensions bring home the potential for geopolitical turmoil to make for more volatile price action in 2020 after a blockbuster 2019 rally, investors, analysts and economists said.
Oil prices jumped Friday, while investors dumped equities and piled into haven assets like gold and Treasurys in a knee-jerk reaction to a U.S. airstrike in Baghdad that killed a top Iranian military commander. Tehran vowed to retaliate — and most observers expect them to follow through.
Here’s what market participants should keep in mind:
Things could get choppy
“We came into this year calling for a continuation of the equity bull market, but with a single-digit return profile and elevated volatility,” said David Donabedian, chief investment officer at CIBC Private Wealth Management, in an interview.
And with the U.S.-Iran conflict unlikely to be a “one-and-done” event, the effect on oil and other markets is unlikely fade quickly as it did in September after an attack on Saudi Arabia’s oil infrastructure that was widely blamed on Iran, he said.
Short-term market volatility is almost entirely driven by policy or geopolitical uncertainty, said Brian Levitt, global market strategist at Invesco, in a Friday note.
“This time will likely be no different. We expect that uncertainty may persist in the near term as markets await potential retaliation from Iran and disruption in the global oil markets,” he wrote.
Room to fall
Stocks ended 2019 on a tear, with major U.S. indexes logging a series of records in December and following through with another set of records on the first trading day of 2020 on Thursday.
On Friday, the Dow Jones Industrial Average
ended with a loss of 233.92 points, or 0.8%, at 28, 634.88, but off session lows. The S&P 500
gave up 23 points, or 0.7%, to close at 3,234.85, while the Nasdaq Composite finished at 9,020.77, a loss of 71.42 points, or 0.8%.
Friday’s decline didn’t even erase Thursday’s gains, but even bullish analysts warned that overbought conditions and expectations Iran will indeed retaliate leave scope for a pullback and increased volatility.
The 2019 stock market rally wasn’t confined to the U.S., with the MSCI World Index rising 12% since early October, said analysts at ING, in a Friday note.
“ And the big rally in risk assets in December certainly looked like a play on the 2020 story – benign conditions, a trade truce and more money printing in G3 economies. Were events in the Middle East to escalate severely, overweight positioning in risk assets could easily trigger a 7%-10% correction in global equity markets,” they wrote.
Not your father’s oil shock
Middle East tensions mean worries over the threat to the world’s oil supply. And while a wider conflict with Iran could create havoc, the potential economic pinch isn’t the same as it was in past decades.
“Our reliance on fossil fuels to generate economic growth has come down substantially over the years. It’s not the ‘70s,” Donabedian said.
It would take a “significant and sustained” jump in oil prices — for example, West Texas Intermediate crude trading above $75 a barrel for an extended period — to begin to raise serious questions about the sustainability of the economic recovery, he said.
In addition, the U.S., thanks to the shale boom, is now a global oil exporter. The growth of the domestic fossil-fuel industry means that higher oil prices are less of a drag on the U.S. economy.
Ian Shepherdson, chief economist at Pantheon Economics, in a Friday note, observed that domestic U.S. oil production runs at almost 13 million barrels a day, while consumption is at 21 million barrels a day.
But while that should mean higher oil prices would depress economic growth, recent experience suggests otherwise. That’s because in the shale area, oil-sector capital expenditures are “acutely sensitive” to prices, even in the short term, he said, in a note.
“When oil prices collapsed between spring 2014 and early 2016, the ensuing plunge in capital spending in the oil sector outweighed the boost to consumers’ real income from cheaper gasoline and heating oil, and overall economic growth slowed markedly,” he said. “This story played out in reverse when oil prices rebounded in the three years through spring 2018, and economic growth picked up even as consumers’ real incomes were hit.”
Bulls remain bold
While analysts see scope for volatility and a near-term pullback, so far events haven’t been enough to turn bulls into bears.
“Historically, regional geopolitical happenings are not the events that end business and market cycles,” said Invesco’s Levitt, noting that market returns, on average, have been positive 12 months after spikes in economic uncertainty, as measured by a widely followed index (see chart below).
“The larger market narrative of slow growth, benign inflation globally, generally accommodative monetary policy globally, and equities still attractive relative to bonds, has not changed. In our opinion, the backdrop for equities and other risk assets remains favorable,” he said.
In addition to events in the Middle East, investors will also work through a busy economic calendar in the week ahead. The main event comes Friday, with the December U.S. jobs report.
Economists surveyed by MarketWatch expect the U.S. economy created 155,000 new jobs last month, down from 266,000 in November. The unemployment rate is expected to remain unchanged at 3.5%.
Sudden rise in crude can spoil India’s Budget math – Deccan Herald
Brent crude futures surged 4.5% to $68.23 per barrel on Friday after US airstrike killed Iran’s top military leader, upping the risk of a broader conflict between the two major oil producers – USA and Iran.
On India, the immediate impact of the crude spike was felt on the rupee as it plunged by 42 paise to close at 71.80 against the US dollar and, haven assets — gold and silver — prices jumped sharply on escalating demand by investors.
In the coming days, it will also translate into a hike in transport fuel bill. If the tension persists, the second-round impact will be felt when higher crude prices zoom the country’s oil import bill, stoke inflation, dis-balance government’s revenues, increase all the three deficits — current account, fiscal and trade deficit — since India is a net importer of crude oil and ships 80% of its requirement every year.
Coming close on the heels of the Union Budget, it will also restrict the government from handing out major tax cuts and other largesse to lift the economy. The Reserve Bank of India, which has already flagged fuel price concerns, may not be able to cut key interest rates even if the economy continues to slowdown.
Despite the US seeking to restrict India’s oil purchases from Iran, the country remains a major buyer of Tehran oil and shipped about 23 million tonne from the Persian Gulf country in 2018-19, which was 5% more than a year before. Iran is India’s third-largest oil supplier behind Iraq and Saudi Arabia. Not only oil, but India also buys natural gas from Iran.
India has, therefore, called for peace, stability and security in the region. Escalating tension could not only result into a potential loss of Iranian oil supply but put in danger the Iraqi and Saudi Arabian region and lead to disruption in seaborne crude supplies if US ships in the region are targeted by Iran.
The US too is India’s significant crude supplier. The country imported 6.4 mt crude oil from the US in 2018-19.
While ballooning import bill puts pressure on current account deficit, the depreciating rupee makes matters worse since India pays for crude in dollars. CAD is a result of higher import over exports in a country.
A rise of crude prices by $10 can push inflation up by about 49 basis points and the fiscal deficit by about 43 basis points, according to RBI. Brent has jumped over 14% since December 2. It can, therefore, spoil India’s Budget math and limit any major concessions in the Budget.
On Friday, crude was trading at its highest level since the attack on Saudi Aramco installation in September last year when it touched $71.95 per barrel.
Experts weigh in on how airstrike could impact stocks, oil prices – WFSB
Oil prices spike after U.S. airstrike — four experts weigh in – CNBC
Oil prices spiked on Friday after the U.S. killed Iran’s top military commander, Qasem Soleimani.
Four experts discuss the impact on energy stocks.
John Kilduff, founding partner of Again Capital, says the geopolitical dynamics have been disrupted.
“I think up 4%, up $2 a barrel, really isn’t pricing in really what this sort of represents, at least to me. This is a huge development. This gentleman was sort of the minister of plausible deniability. When you hear about attacks on … Saudi Arabia or some of the other instances that we’ve had and they can never quite trace where it leads to, he was the guy. He was the guy that got the direction or the sort of generalized orders from the Ayatollah to go out and do this sort of stuff. And so taking him out was a big deal, and the stakes here are quite high. Iran’s going to have to do something, or they’ll completely lose face, so that’s why the oil market is on tenterhooks.”
Brian Levitt, global market strategist at Invesco, says stocks should shake it off over the long term.
“The big macro narrative is it’s still a slow growth world, inflation is benign, policies are accommodative, equities are cheap to bonds. None of that changes. Now, these types of events in a dangerous world happen. We saw it last year with the Saudi oil fields, and yet it was a year that markets were up 30%. I think what most investors would be surprised to know is that when geopolitical uncertainty spikes and when you get to these near-record highs and geopolitical uncertainty markets are actually positive 12 months.”
Alec Young, managing director of global markets research at FTSE Russell, says there are select names in the energy space that could move higher here.
“Everyone hates energy. It’s universally underweight, millennials are divesting, everyone knows the bearish narrative, and I think this is a reminder that you can never get too complacent in your market positioning. So I think there will be geopolitical premium that goes into the oil price. I think that puts a bid under a lot of the big oil companies, great dividend yields there, everyone’s looking for income, so I think people are going to maybe take a slightly more positive, constructive view on energy, which is good.”
Helima Croft, head of commodity strategy at RBC Capital, says this is a space to watch closely.
“We were up above $100 five years ago when you had ISIS on a tear in Iraq. Now with U.S. production, that’s really blunted the impact in the market of geopolitics, but I do think we really do need to pay close attention to what the Iranian response will be. I mean, Qasem Soleimani was considered the most dangerous operative in the Middle East, not just in Iran, and so the question is how does the Iranian leadership respond? There have been attacks on tankers since May, sea ships, and in September, it took half of Saudi oil production offline temporarily. So they’ve demonstrated a capacity to be very disruptive. I think we do need to pay attention to what comes next.”
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