Stop me if you have heard this one before. We are currently at war with a country in the Middle East, oil prices are spiking and that is sparking renewed inflation fears which could lead to rate hikes which could cause the market to sell off. Sound familiar?
Let’s start at the beginning of the year. I was expecting volatility early in the year before Iran kicked off. We can’t forget this is a mid-term election year. The hallmark of mid-term election years are higher volatility and muted returns.
As I have written often, markets don’t like uncertainty. So not knowing which party will be in control of the House and Senate gives investors pause. There is some good news to add to this. In the year following midterms, market returns have been strong as investors have a better sense of policy direction.
Now we add Iran to the equation. The questions with regards to this war is very simple…. how long is the conflict going to last? About 20% of the world’s oil supply runs through the Strait of Hormuz. Even though the US is now the world’s largest oil producer, our prices have jumped about 20% since the first days of the attack. On February 27 the S&P, though it had been choppy to start the year, was still positive. Since February 28 the S&P is down nearly 5%. That hurts, but a short-term conflict can be shrugged off by the markets. Don’t forget, we are only one year removed from an 18% selloff after “Liberation Day” only to end the year with a double-digit positive return in 2025. Additionally, a 5% pullback is part of a normal, healthy market. In fact, since 1928, the S&P has had a 5% pullback during the fiscal year 94% of the time. A 10% correction, on average, occurs once per year.
The reason I’m still positive if this is short term is that the economy, both here and abroad have shown signs of strength and resilience. Initial jobless claims are low, continuing claims are low, inflation readings (pre-war) were trending down towards the 2% target, approximately 82% of S&P 500 companies exceeded earnings expectations in the 4th quarter. China and Japan have both had positive growth and inflation news. So, there are enough signals out there that without this conflict, there should be positive momentum in the markets
But the thought of this war dragging on and energy prices shooting higher has caused significant panic. A longer conflict could trigger a classic risk-off response: higher oil prices, weaker equities, a stronger U.S. dollar, widening credit spreads, and a rally in sovereign bonds as investors seek safety. Per economist Talha Khan “In more extreme cases, if oil prices rise enough to materially slow demand, the dynamic can shift toward stagflation, characterized by higher near-term inflation followed by weaker growth,”
So, after all that positivity what’s the answer? It’s simple, we just position your portfolio with what’s in front of us if this were to drag on. Gold has done its job as a solid defense in the portfolio. Alternative investments such as market neutral strategies and private market investments do a good job of diversifying from the public markets. The bond market continues to play the defensive role we expect post the 2022 selloff. As technology has progressed, we have seen cybersecurity stocks provide good defensive positioning as well during times of conflict.
My hope is that this is just a blip on the radar (the stock market radar not the bombs flying across the Middle East). A short-lived conflict will be very easily overcome by the markets. A longer-term conflict will require more individual attention to your plan. Because as we have always discussed, your plan is your plan, not someone else’s. Theres a lot of negativity out there, please feel free to call me with any and all questions. As always, please feel free to share this with anyone you think may benefit.
Rob