Dear Valued Clients and Friends,
In this week’s Dividend Cafe:
- We look at the impact of the military operation in Iran on markets, the enhanced volatility it has created, and what it means.
- We evaluate the impact on prices, from oil to aluminum to global shipping, and how that could impact the economy.
- We look at scenarios for an endgame and how investors should be thinking.
Let’s jump into the Dividend Cafe …
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War
While the length of this military operation is unknown at this time, we know it is dangerous, violent, unpredictable, and precarious. It is never comfortable for me to be writing about something like this in the context of markets and financial impact when human life is on the line. I do not minimize the human element of the story, and I earnestly hope for a quick and successful end to the operation. I even hold out cautious optimism that there may be a better path for Iran when this is all said and done, and certainly a safer existence for our Israeli allies.
That all said, today’s Dividend Cafe is to look at the market ramifications and expectations of all this. War is a military event, a political event, a cultural event, but it is also an economic event. I hope today’s commentary will provide a useful framework for thinking about it, even amid so many unknowns that render any thinking difficult.
If Nothing Else, Volatility
As I type, the Dow is trading at 47,400, down about 1,500 points from last Friday’s close (-3%). If it has moved up a great deal by the time you read this or down much further, forgive me. But that is actually sort of the point – because both are possible. A 3% drop in the market, with an unexpected war breaking out in the world’s most volatile region, is actually not that much. However, note the intra-day volatility this week …
- Mon: Down -600 points at one point, closed basically even on the day
- Tue: Down -1,275 points at one point, closed down -400 points on the day (or up +875 points from the intra-day low, after being up +1,070 points from low point to high point)
- Wed: Down -150 points at one point, closed up +240 points on the day (with a 500-point swing intra-day from low point to high point)
- Thurs: Down -1,200 points at one point, closed -785 points on the day (with a 1,000 point swing intra-day from low point to high point)
- Fri: Down -950 points at one point (before I has to submit this); currently down -560 points
I do hope you get the idea. The intra-day swings are substantial, and when markets start moving up or down by over 1,000 points almost every day in the middle of the day, regardless of what the closing price to closing price movement proves to be, you have a market that is excessively touchy. It is perfectly fine to refer to this as “volatility,” and in fact that is what I did in the headline of this section. But what it really should be called is “avoidable” … as in, avoid the temptation to try to trade in and out of it. Market timers get rolled in periods like this. Guessing the day-to-day is obviously impossible because guessing the next hour is impossible. Keep in mind – nothing traded this week because, “we were worried about A, but then an hour later we found out B.” No one knows A, B, C, or D right now – they don’t know anything. Traders can guess. People can speculate. And folks can even pretend they know something (“it is really clear to me that Iran is going to [fill in the blank]” or “the President will surely end up [fill in the blank]”)
The only thing clear to me is that I am not taking investment advice from these people. They know nothing.
So why the volatility when so many people know nothing? Because it is not based on knowledge, or even perceived knowledge. It is what happens when an expensive market meets big uncertainty – a touchiness that evidences itself with buy and sell decisions that are not rooted in fundamentals, in analysis, or in an investor’s own stated mandate. When decisions are disconnected from fundamentals, analysis, and investor goals, they become connected to emotion and sentiment. And that always leads to great decisions, am I right?
There is some outcome coming from all this, and there will be more known knowns than known unknowns at some point here. But in the meantime, count on nightmares for market timers and pretty standard fare “elevated volatility.”
It should not matter one bit to you. If it does, I believe there is something wrong with your portfolio.
How Long?
One of the reasons that gaming out a market thesis on the current war effort is so ridiculous is that gaming out a war thesis, itself, is so ridiculous (with apologies to those of you who are currently senior Pentagon officials with maximum security clearances receiving daily briefings). What we know is that market uncertainty has to do with the knock-on effects of current regional instability (ports, straits, shipping, oil exports, natural gas production, and more), and that we cannot say how long those things remain problematic if we do not know how long the military action will continue. Now, even if we did know, it does not mean we would know how everything else will shake out. Should Iran’s ability to resist this come to an end (depleted munitions, decimated leadership, etc. – near the end of today’s commentary you will see some data that suggests this is not as outlandish a prospect in the near future as you might think) it does not mean we would know who will be running Iran, what the parameters for such leadership will be, who will be trading with Iran and who will not, what the repercussions with other Middle Eastern countries may be as it pertains to U.S. relations, etc.
What we have here is a period of uncertainty that requires more clarity before other uncertainties can begin to be cleared.
This is not rocket science, but a conflict that is clearly on its way to resolution in days or even weeks will have much less market impact than one that lasts months on end. The degree to which Iranian rockets are being intercepted leads me to believe that the latter is less likely than the former, but I cannot speak with any specificity.
Realistically, I do believe the United States objective here is a short-term declaration of success, a new group of leaders in Iran, and as little damage to American lives and interests as possible. I would not bet against that outcome, even if the path to it is murky at this stage.
Oil, Obviously
As I am typing this Friday morning, an hour into trading, WTI crude oil is trading at $88.69, up +9.5% on the day but up +32% on the week. It was up a whopping +5.5% on the first trading day (Monday) after the operation began last Monday. When I was speaking to clients about this last night in Nashville, the report was “up +17% on the week.” And here we are +32%. So yes, this is the story – not just the immediate move in oil prices after things began, but the two-day, four-day, and six-day steady move higher.
The Strait of Hormuz is essentially closed, keeping ships from transporting not just oil and gas but also other key cargo (see below). A reboot of Qatari LNG production is at least a couple of weeks off, and that really is the best case.
The short-term impact of oil prices across the U.S. economy (not merely gas in automobiles but the transportation costs that create pass-through effects to other goods) is the most direct economic exposure to this operation. The first few months after a major spike in oil prices generally lead to pretty muted equity markets, but that could be more sentiment-related than fundamental. The point is, regardless of the reason, out of the last ten times oil had a sudden spike of +20% or more, the market was measurably higher 90 days later only twice. There is generally a muting effect from such a spike.
The administration is reportedly considering various interventions, all of which I imagine would be counter-productive and distortionary (and wholly unnecessary). Talk is circulating about releasing oil from the Strategic Petroleum Reserve (as if domestic production is remotely threatened here). Other ideas I have seen circulated are that the Treasury Department, itself, trades oil futures (to presumably manipulate prices lower?), an idea so stupid I am just grateful it has not been verified by anyone in the administration, as well as waivers of certain regulatory requirements about fuel-blending (I suppose this is the best of the three ideas).
The Container Store
Shipping costs were up +7% this week after what had been seven weeks of declines, but it has to be said that even with a +7% increase, they are still relatively cheap (for now). When a global player like Maersk suspends major shipping services between the Middle East and Asia and the Middle East and Europe, you know that this can become a very serious thing. What is right now just two routes and being portrayed as “precautionary” could easily become a much bigger story. And while the Strait of Hormuz discussion has largely centered around impact on oil prices thus far, there are currently 147 container ships “sheltered” in the gulf, going nowhere, doing nothing.
Price Level Considerations
10% of global aluminum supply comes from the Middle East region (h/t Peter Boockvar). Prices this week hit a four-year high. The spike began a year ago with the imposition of tariffs, but the events this week gave it another leg up, no doubt.
Most accounts seem to indicate gas prices went up about $0.20 cents per gallon this week. I don’t want to belittle that move because I have no doubt that, on the margin, it impacts the pocketbooks of many lower-income and middle-class wage-earners. But I do not believe it marginally moves things a lot. Now, that $0.20 could become $0.40 or $0.50, and that becomes economically significant. And even at $0.20, it might become politically significant, just in terms of changing a political narrative (or removing one of the White House’s favorite talking points this year about lower oil and gas prices). But I think two things are objectively true at this point:
- A $0.20/gallon increase, if it stays there, is not likely to be an economic or political needle-mover
- Should the military situation stabilize in the weeks ahead, and oil prices re-center around $65-70, versus $85-90, even that increase is unlikely to last.
In other words, TBD.
I would also argue that if there proves to be long-term success in this operation, it could very well provide some long-term ease in gas prices to the extent some reasonable stability boost can become expected in markets. That may very well prove elusive, but there is that possibility should the board come together the right way (less unpredictability about Iran, their intentions, and the Strait of Hormuz), which creates a repricing with less of a premium for the “Iran factor.” I absolutely admit this is (a) by no means assured, and (b) a ways off, regardless.
The Politics of It All
I suppose a tangential element of market impact in this is the potential for political impact. Now, there is no doubt there is going to be a political impact – that is not hypothetical. But the political impact becoming pertinent to markets is merely potential. Does the political impact of all this, in the end, move the needle enough that it impacts midterms, committees, mandates for legislation, political capital for one’s agenda, etc.? It is way too early to know if this will happen, and how, and to what extent, but it is not too early to know that all of this could happen.
Let’s take this one step further, though. The early indications are that polling on this strike and operation appears to be negative for the President. I suppose some readers may conclude from that fact that this represents either a liability for the President or, at best, something that doesn’t move the needle either way. And I wouldn’t debate you if you believe that is the highest probability. But I will say this: There are scenarios in which the way this all goes and ends accrues very much to the benefit of the President (use nothing more than your objective imagination to consider what those scenarios may be). I am not predicting this, but I am confident it is a possibility. And of course, there are ample scenarios in which this becomes politically catastrophic for the President.
You will find speculating on crypto coin pricing more reliable than this political prognostication. But from a market perspective, it needs to be understood that a wide array of political fallout options in both directions exists.
Where We Go from Here
I do feel comfortable saying that the impact on oil prices and global shipping will largely prove to be a by-product of how long the entire operation and endeavor plays out. What I do not feel comfortable saying is how long that will be. Where things stand with the power vacuum in Iran is not clear. What the will of the Iranian people will prove to be is not clear at this time. What Iranian military capabilities actually are is not clear at this time. What we do know is that on day one, Iran launched 350 ballistic missiles, and on day two, they launched 175. Yesterday they launched just 15, and the day before 28. In the first three days, they launched over 1,000 drones. The last two days, they have launched 42. There is ample reason to be suspicious of Iran’s ability to compete against U.S. and Israeli forces.
And as for those elevated oil prices … It is beyond obvious that this is a temporal condition, even if the term’s length is uncertain. What may be less obvious is that this could end up pushing oil prices much lower in the end. While nowhere near certain, should the end outcome here result in a regime in Iran friendly to the U.S., with there being an appetite for Iranian production to come into global markets, that represents a significant boost to world supply that would put downward pressure on prices (Iranian oil output to global supply in a sanctions regime has been minimal). A lot has to happen between now and then, but the backwardation in oil markets is not exactly resisting that outcome (see Chart of the Week below).
Conclusion
Investors should not be altering their asset allocation strategy because of this military operation. In fact, their asset allocation should have already accounted for the very possibility – indeed, inevitability – of various military and geopolitical instabilities throughout one’s investing life. Those overweight Energy coming into this are probably doing better than those who weren’t, but the time for that overweight was before, not during.
Investors should be prepared for continued day-to-day volatility as uncertainty persists. And they should not care or respond a whit.
The length of the conflict will determine much of the market direction here, most notably in the impact on the real economy, on shipping of goods and containers, and, of course, energy prices. The magnitude of the conflict (and length) will also speak to the political repercussions.
And day by day, week by week, investors who are compounding dividends from real companies that continue doing what they do through the incident have a portfolio working by design. To that end, we work.
Chart of the Week
Oil futures have skyrocketed in the immediate short term, but moved lower a year out.
Quote of the Week
“It is time that we steered by the stars, not by the lights of each passing ship.”
~ Gen. Omar Bradley
* * *
I am leaving Nashville shortly for a conference and speech in Georgia this weekend, then off to Miami for another conference and speech, then back to New York City in a few days. Reach out with any questions, any time. And God Bless America.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
thebahnsengroup.com
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet
