Stocks turned lower once again as investors fretted over events in the Middle East. Those fears were confirmed last night as Iran launched missile attacks against two airfields in Iraq that housed U.S. troops. So far there have been no reported U.S. casualties, but clearly the attacks represented an escalation of tensions. Separately, a Boeing 737-800 crashed on takeoff from Teheran. This was a 3-year old predecessor to the 737 Max that is now grounded. All 176 passengers aboard are reported dead. A black box was recovered. The plane was operated by Ukraine International Airlines. Sources in Iran say the plane had technical problems that caused the crash. Missile or military actions were not involved allegedly. Many details to come, but Boeing’s stock is down over 2% in early pre-market trading and that will add weight to the Dow’s morning decline that is expected.
While futures are down this morning, they have recovered from lows reached soon after news of the bombings hit the wires. With few casualties, and apparently no Americans, the Iranian retaliation resembled the bombing of airfields in Syria by the U.S. after Assad used chemical weapons; largely symbolic. What is at issue now is the next step. There is little doubt that the rhetoric from both sides will escalate. We will keep increasing economic pressure on Iran, a country suffering much economic pain already. Its leadership appears unloved from within. To some degree that has to impact its options. Iran could escalate military confrontation in a serious way, but it knows Mr. Trump will strike back hard if it deals any serious blow to U.S. interests. That still remains a risk, but it is one that needs to be viewed in context. What does Iran stand to gain by further military actions?
It is notable that nations both in the Middle East and in Europe are working behind the scenes to try and calm the waters. Iran has few obvious allies. It shares some common interests with Turkey, and Russia remains ready to help stir the pot for its own interests. But otherwise, it stands somewhat isolated. The same is true for the U.S. Our European allies want no part of this confrontation. They never withdrew from the Iran nuclear deal and want to develop stronger economic ties with Teheran. Events of the past two weeks won’t help that cause. Thus, the most likely outcome could be some third party efforts to bring both sides to the negotiating table to either resolve their differences or to at least calm the waters for now.
Markets seem to appreciate this. Oil prices are up very modestly this morning. As I noted previously, Iranian production is a very small part of overall world supply, and any decline can be offset by accelerated production elsewhere. Closing the Strait of Hormuz is always a threat, but Iran would suffer more than anyone else economically at a time when it can least afford extra economic damage. Thus, the measured reaction of markets so far seems in line with what is most logical to expect. That doesn’t mean, of course, that what’s expected is what is going to happen. Thus, volatility could be higher than normal until events either calm down or escalate further. What seems apparent right now is that the events of last night are not likely to be viewed as a major escalation that will serve to spin the military picture out of control.
Usually, the first week in January is dominated by economic data. Because New Year’s fell mid-week and the December employment report is delayed to this coming Friday, that data is more spread out this time around. After the big gains reported for November, more muted increases are forecasted for December. While manufacturing in December continued to contract, most other economic data to date is supportive of an economy growing at a 2% or slightly better pace with little apparent inflation. Bond rates have backed off a touch to reflect that. Declines in the trade deficit will also serve to inflate GDP growth numbers.
As the new year begins, investors should be watching the relative performance of various equity sectors. Obviously, energy and defense have gotten a short-term boost from events in the Middle East, but it is unclear whether those gains are sustainable if the tit-for-tat set of events calms down. The big winners so far appear to be the old favorites, notably in the tech sector. The underperformers appear to be the low-risk, high-dividend names that got a great boost in the first 9 months of 2019 from lower interest rates. 2020 is just a week old and it is far too early to draw any conclusions. Earnings season is approaching and that will mean a lot as we look ahead. But as of now, there are few signs that investors intend to proceed down a different path in 2020. Valuation matters but so does growth. 2020 will be a year where 5G emerges, but it will still be a trend for the future. Movement to the cloud will continue at a strong pace. The media streaming wars will escalate and investors will get a better idea of who might be the ultimate winners and losers. Biotech stocks are attracting attention as they develop new drugs and get merger offers. Manufacturing companies hope to rebound. They should if the economy remains solid. The decoupling of our economy and China’s could escalate even without further tariff action. U.S. companies will continue to diversify supply chains to reduce Chinese-related risks. The consumer will continue to shop online and traditional retail remains risky. As a nation we still have far more retail space per capita than any other major nation. Tesla will attract more buzz but it is argumentative how fast electric vehicles catch on overall. Interesting times lie ahead.
Today, Kim Jong-Un is 36. While I don’t normally comment on the birth dates of deceased people, I should note that he shares a birth date with Elvis Presley, Stephen Hawking and David Bowie. I would have loved to be the fly on the wall watching the four of them in one room.
James M. Meyer, CFA 610-260-2220