Welcome to 2020. The New Year sure started with a bang. Stocks rose about 1% yesterday as investors welcomed in the New Year with enthusiasm. But the overnight news that U.S. forces had killed a key Iranian general in Baghdad has markets poised to erase all yesterday’s gains and then some when trading begins this morning.
In a daring raid, U.S. forces killed General Qassem Soleimani and other key aides as they were allegedly planning further strikes against American installations and personnel in Iraq. Both Iraq and Lebanon have become caught between Iran’s push to increase its dominance in the Middle East via proxies like Hezbollah and their desire to maintain some semblance of freedom from a non-Arab power like Iran. Both want to avoid what happened in Syria. To do so, some level of support from the U.S. may be desirable without allowing America to dominate either in any manner.
Complicating matters, there is no rational reason for either the U.S. or Iran to want an all-out war. Iran is already squeezed by U.S. sanctions and has an obsolete navy and air force. Closing the Strait of Hormuz, one possible tactical option, would almost certainly injure Iran more than anyone else and invite even harsher sanctions. It would also invite the wrath of many Arab states that depend on the export of oil. The U.S., under President Trump, wants to withdraw as much as possible from the Middle East as long as the political environment we leave behind is stable enough that U.S. interests won’t be threatened.
Markets are reacting sharply this morning for several reasons. First, Wall Street hates surprises. Traders sell first and ask questions later. Second, despite some of the rational points made above, not all moves are rational. Logically, the U.S. attack last night demands a response even if that action itself was a reaction to prior Iranian provocation, including the attack on our embassy in Baghdad. Certainly, world leaders around the world today will be taking whatever steps they can to calm tensions. But with that said, and given how the U.S. turned its back on the Kurds in Syria, don’t expect the U.S. to garner any military support for whatever actions it might consider any time soon unless events escalate out of control.
That, of course, is the big risk. A relatively minor assassination triggered World War I and similar escalating events are a risk here. At the moment, the odds of such catastrophic outcomes are low, but they certainly are higher than they were yesterday.
The obvious question is “Where do markets go from here?” The answer is just as obvious; it depends on the next set of events. Over the past year, there have been confrontations between the U.S. and Iran that escalated tensions but dissipated fairly quickly. If that is how the storyline plays out this time around, the same will be the case again. Stocks will recover their early losses and oil prices, up about 4% this morning, will give back part or all of that increase. But rational thought and economics won’t answer the political questions. So, today we remain on watch, hope calmer heads prevail, and wish for a return to some level of calm. Iran’s reaction, other than verbal condemnations, could take days or weeks to play out.
Since President Trump has made it clear that he doesn’t want war and would like to withdraw American forces from the Middle East as much as possible, Iran and others in the region have pressed their options to see how far and how quickly they could gain influence. It is also obviously in Russia’s interest that we leave a void that it can fill. Last night’s attack sent a clear message, that we want to dictate our own pace of withdrawal and if adversaries push too hard, our reaction can be quite unpleasant. If that point is received properly, perhaps tensions can begin to deescalate. The next move is Iran’s. No move could be the right move, at least for now, and it may be the most logical one.
Away from Iran, the outlook is good. The reaction in the futures markets, a move down of less than 1% in early morning hours, seems appropriate. Bad news with limited economic consequences often causes one-day moves of this nature. The media may talk of black swan unintended consequences all day today (it has little else to talk about except the same old political stories) but, so far, those fears aren’t justified. Indeed, without any response from Iran toward further escalation, the lows at the open could even prove to be the lows of the day. With that said, clearly the Middle East will require more investor attention in the weeks ahead. Hopefully, the worst news is now behind us.
As we start the New Year, I want to introduce Jim Vogt as my co-Chief Investment Officer. Jim has been running our research effort for some time and is going to start working with me on some of the big picture and overall strategy issues that we have to wrestle with every day. I will continue to write the market letters on Monday and Wednesday but Jim will start writing them on Friday. Depending on our schedules, I might write a Friday letter or two and he will fill in for me on days I’m not available. Hopefully, you will see we agree much more than we disagree but a little back-and-forth makes for a healthy dialogue.
Today, Eli Manning is 39. Mel Gibson is 64.
James M. Meyer, CFA 610-260-2220