Will
Geopolitical Tensions Effect Oil and Stock Markets?
By the
Curmudgeon
Introduction:
Investors and speculators appear to be stuck in a perennially bullish
posture that treats every stock market decline, potential selloff, or risk
factor as an opportunity to buy fear and prepare for stocks to rally
higher. The mentality continues to be buy the dip and sell puts whenever volatility spikes.
"Welcome to the brave new world where it appears that little short of
full-fledged world war between nuclear-armed powers would be required to have a
durable impact on financial markets. And even then, some begin to wonder,"
Reuters' Sujata Rao and Dhara Ranasinghe wrote. Lets examine, whether that opinion is valid.
..
Geopolitical Risk Events and the Stock Market:
No doubt worries over Iran have investors on edge, said LPL Financial
senior market strategist Ryan Detrick. Stocks could be volatile for a while,
but the impact to stocks from geopolitical events historically has tended to be
short-lived, he added.
Mr. Detrick is correct most of the time.
A recent Schroders report identified the 1990 Gulf War, the 2001 9/11
attacks on New York and the 2003 Iraq invasion as the most monumental
geopolitical risk events here of the past 30 years.
As we can see from the table below, courtesy of LPL Research (via Sam
Stovall of CFRA), there have been only two double digit S&P 500 drawdowns
due to geopolitical events since North Korea invaded South Korea in 1950.
Heres a graphic which charts the world uncertainty index vs global stocks
since the 2008 financial crisis:
The market has taken a view based on a decades worth of experience that
this (Iran-U.S. conflict this month) is not going to escalate out of control,
said Societe Generale strategist Kit Juckes.
Geopolitical Events, Oil Price Spikes, and Market Impact:
For decades, the energy price impact of major geopolitical conflicts has
been the main concern to the wider economy and world markets. The threat of oil
supply disruption has been a shadow on the global economy ever since a
quadrupling of oil prices during the 1973 OPEC oil embargo and a 30% jump in
1990.
Indeed, a recent Schroders report identified the 1990 Gulf War, the
9/11/2001 attacks on New York and the 2003 Iraq invasion as the most serious
geopolitical risk events here of the past 30 years. Those all had the potential to curtail middle
East oil supplies, especially since most of the 9/11 suicide terrorists were
from Saudi Arabia and presumably received financial aid from that country (of
course, the U.S. never retaliated).
A geopolitical risk index compiled by U.S. Federal Reserve Board researchers
Dario Caldara and Matteo Iacoviello rates the
September 14, 2019 Saudi oil field attacks at a relatively high 185 points, but
well below the 2003 U.S. invasion of Iraq that scored 545 points.
How could that be when Saudi
Arabia is still the worlds largest oil exporter and its oil production is
threatened?
Its because oil price rises these days tend to be briefer than in the
past. Witness last week when oil prices
spiked the day after the U.S. killed Irans top general but gave up all their
gains by the end of the week.
This tepid crude oil price rise (and short-lived stock market decline)
response to potential oil supply disruptions, reflects the changing nature of
energy usage and geographical sources of supplies.
When Iraq invaded Kuwait in 1990, oil was a key factor and rising crude
prices put pressure on an already weak U.S. economy. But it is important to
remember that in 1990, the U.S. was a major oil importer, and we were not a
dominant energy producer on the global stage. Today, the U.S. is the worlds
largest oil producer and our reliance on imports has been in decline for years
as per this graph:
U.S. shale oil producers can now step up to offset price spikes stemming
from Gulf supply disruptions, regardless of local politics or OPEC action,
while the rise of renewable energy sources amid fears of climate change is
happening at a rapid pace.
Also, technology advancements and new efficiencies means that far less oil
is needed to produce a dollar of global GDP today than was the case during the
Arab oil embargo of 1973, which was largely responsible for the 1973-74
recession. U.S. energy consumption has
been relatively flat over the past decade. Fewer imports, more production, and
level consumption mean less reliance on middle east oil.
..
Iran and Iraq Instability vs the Oil Market:
Will Iran retaliate further (after their drone strikes on U.S. military
bases in Iraq as a response to the U.S. killing of Iran Revolutionary Guards
#1 commander Soleimani)?
Will Iraq oil supplies be disrupted due to the worsening conflict there
with U.S. troops ordered to leave by Iraqs parliament?
Iran has been blamed for attacks on Saudi oil facilities and oil tankers in
the Strait of Hormuzthe thoroughfare for about a third of the worlds seaborne
oilover the past year, including attacks on Abqaiq and Khurais
in September 2019 that rocked global oil markets. Iran has denied
responsibility.
An ongoing concern is that a conflict in the region could result in Iran
closing off the Strait of Hormuz, a potential oil chokepoint. The strait, which
links the Persian Gulf and Asian markets, and through which an estimated 40% of
the world's crude passes every day, is bordered on one side by Iran and on the
other by Oman. Iran has pledged to close
the strait in the past if war breaks out.
Could that really happen?
BCA (formerly known as Bank Credit Analyst) Research provides some insight and clarity:
1. Iran is not yet likely to court a full-scale American attack by shutting
down the Strait of Hormuz. It is more likely to retaliate
via regional proxy attacks, including cutting off oil production, pipelines,
and shipping at a time of its choosing. If Trumps pressure tactics succeed,
it will advance Irans nuclear program rather than staging large-scale attacks.
However, Iran would have to create and maintain an oil supply shock the
size of the September 2019 attack in Saudi Arabia for four months in order to
ensure that American voters would feel the negative impact at the gas station
before the November 2020 Presidential election.
The underlying US-Iran conflict will persist and create volatility in oil
markets in 2020 and beyond. We also remain on guard for ways in which the Iran
dynamic could affect Trumps re-election odds and hence US policy and the
markets over the coming year.
2. Iraqi instability will worsen as a result of the past months events, bringing 3.5 million barrels of
daily oil production under a higher probability of disruption than when we
first flagged this risk. Supply disruptions there or elsewhere in the region
would hasten the drawdown in global inventories and backwardation of prices
occurring due to the revival in global demand on China stimulus and OPEC 2.0
production cuts.
3. Continued oil volatility, as in 2018-19, should be expected, but the risk for now lies to the
upside as Middle East tensions could cause an overshoot. We remain long Brent
crude and overweight energy sector equities.
..
More fallout in the U.S.-Iran standoff (from Geopolitical Futures):
Unidentified aircraft targeted arms depots and vehicles carrying ballistic
missiles of the Iran-backed Popular Mobilization Forces in Abu Kamal, Iraq,
near the Syrian border. The attack killed eight Iraqi fighters. The Iraqi and
Syrian governments have not commented, and no one has claimed responsibility
for the attack. Though the U.S. said it would sustain its maximum pressure
campaign against Iran, its U.N. ambassador said the U.S. was ready to
negotiate without preconditions.
Other interested parties are preparing their own responses. The European
Unions Foreign Affairs Council has convened an emergency meeting on the
situation in Iran (and Libya).
Japanese Prime Minister Shinzo Abe will visit the Middle East to speak with
leaders of the United Arab Emirates, Saudi Arabia and Oman about cooperation
with the Japanese Self-Defense Forces in the Strait of Hormuz. Japan intends to
deploy a destroyer and two P-3C patrol planes to escort oil tankers through the
strait and gather intelligence.
.
Late Breaking News from Iran and Iraq:
Could a civil war be in the making in Iran?
On Saturday, protesters in Tehran (Iran's capital) demanded the resignation
of senior leaders following the admission by authorities - after days of
denials - that Iranian forces accidentally downed a Ukrainian passenger plane,
killing all 176 people on board. Ukraine International Airlines flight PS752
bound for Kyiv, Ukraine, crashed minutes after take-off from the Imam Khomeini
International Airport in Tehran on Wednesday.
That happened hours after Iran launched missile attacks on U.S. armed
forces in Iraq in retaliation for the U.S. assassination of top Iranian
commander Qassem Soleimani. Yet in the days after PS752 crashed, Iran
stated they had no role in downing the Ukrainian civil aircraft. Iranian officials said it was due to a
mechanical failure.
On Sunday, more protesters gathered in Tehran and other cities (including
Kermanshah, Ahvaz, Rasht, Yazd, Semnan and Mashhad) to denounce what they
called lying and incompetence by the countrys leadership, as additional
security forces were deployed outside a university where hundreds of protesters
had assembled.
The public rebuke reflects the challenges Iran faces in trying to keep a
lid on months of unrest fomented by various social classes and ethnic
backgrounds as the economy reels and foreign pressure mounts.
The states legitimacy is severely challenged by people, regardless of
their background, said Alam Saleh, an Iran expert
and lecturer in Middle East politics at Lancaster University in England. He
said Tehran would need to enact reforms to show it is listening. If not,
[Iran] will have prolonged protests.
A security crackdown in NovemberIrans deadliest in decadeskilled
hundreds, rights groups said, after protesters objected to austerity measures
that raised fuel prices.
Iran has reinforced links with armed militias in the region, including
Lebanons Hezbollah and Shiite militias in Iraq, some of which
have recently attacked U.S. positions.
.
Attack on an Iraqi Airbase hosting U.S. Military and Contractors:
A volley of rockets slammed into the Al-Balad [1]
Iraqi airbase north of Baghdad, where U.S. forces have been stationed. The attack wounded at least four Iraqi
servicemen. The base had held a small U.S. Air Force contingent as well as
American contractors, but a majority had been evacuated following tensions
between the U.S. and Iran over the past two weeks, military sources told AFP
news agency.
Note 1. Al-Balad is the main airbase
for Iraqs F-16s, which it bought from the U.S. to upgrade its air capacities.
In a statement, the Iraqi military said eight Katyusha-type rockets landed
on Al-Balad airbase - 80 kilometers (~50 miles) north
of the capital - wounding two Iraqi officers and two airmen.
The U.S. has blamed Iran-backed militias for the attack, but no one
have taken responsibility for it.
Iraq military bases hosting U.S. troops have been subject to volleys of
rocket and mortar attacks in recent months that have mostly wounded Iraqi
forces, but also killed one American contractor last month. That death set off a series of dramatic
developments, with the US carrying out strikes against a pro-Iran paramilitary
group in Iraq as well as a convoy carrying top Iranian and Iraqi commanders
outside Baghdad airport.
Pro-Iran factions in Iraq have vowed revenge for those raids, even as Iran
said it had already responded in proportion by striking another western
airbase where US soldiers are located.
Rocket attacks against Baghdads high-security Green Zone, where the U.S.
and other embassies are based alongside international troops, are still taking
place.
So after almost 17 years of U.S.
military presence, Iraq seems to be more unstable than ever, largely due to
Iran backed militias trying to gain political influence in the country by
their repeated attacks.
The upshot is that turmoil in Iraq would severely diminished Iraqi oil
output which has the potential to significantly alter the global supply
picture. Iraq is the second-largest oil
producer in the Organization of the Petroleum Exporting Countries. Excluding
exports from the Kurdish Regional Government, Iraq exported around 3.3 million
barrels a day in December, according to shipping tracker Kpler.
The biggest risk is that
Iraq increasingly sides even more with Iran and
that Iraq is hit by sanctions from the U.S., said Bjarne Schieldrop,
chief commodities analyst at SEB Markets.
Conclusion:
While we urge investors to not dismiss geopolitical crisis as irrelevant,
one or more of them could end the oil and stock market complacency of the last
several years. In
particular, an event which the Fed (and other Central Banks) cant
control could cause economic weakness and trigger a serious correction or bear
market in global equities.
Today, tweets seem to have more impact than geopolitical events as per
Closing Quote:
Todays markets are whipsawed by political slings and arrows, often in the
form of tweets or breaking news reports. And investors increasingly are
reacting impulsively to a reality thats shifting minute-by-minute, said Brent
Schutte, chief investment strategist at Northwestern Mutual Wealth Management
Company, in a Monday note. Put differently, broad swaths of equities can flip
from winners to losers in an incredibly short time period perhaps in the wake
of a single tweet.
Good luck and till next time
.
The Curmudgeon
ajwdct@gmail.com
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the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has
been involved in financial markets since 1968 (yes, he cut his teeth on the
1968-1974 bear market), became an SEC Registered Investment Advisor in 1995,
and received the Chartered Financial Analyst designation from AIMR (now CFA
Institute) in 1996. He managed hedged equity and alternative
(non-correlated) investment accounts for clients from 1992-2005.
Victor
Sperandeo is a historian, economist and financial innovator who
has re-invented himself and the companies he's owned (since 1971) to profit in
the ever changing and arcane world of markets, economies and government
policies. Victor started his Wall Street
career in 1966 and began trading for a living in 1968. As President and CEO of
Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and
development platform, which is used to create innovative solutions for
different futures markets, risk parameters and other factors.
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