Perspective Time: Geopolitics Hits Markets, But Losses Not Too Steep Yet And Volatility Tame

The new week kicks off a bit differently than people might have expected at the end of 2019, when all eyes were on the huge Q4 rally and the approach of earnings season. 

Last Thursday’s U.S. military attack sent major indices to their biggest daily losses in a month on Friday. Sellers piled on in the pre-market hours Monday, with major indices taking another leg lower after sharp losses in Europe and Asia overnight.

We obviously saw some things happen over the weekend in Iran and Iraq, but people shouldn’t lose their minds over it. Markets are down, but not a crazy amount. Also, volatility is up, with the Cboe Volatility Index (VIX) jumping above 16 early Monday to its highest level in a month. That compares with recent lows down near 12, but VIX hasn’t popped that much, all things considered.

Bonds barely moved early Monday. The 10-year Treasury yield, which had looked like it might be primed to test 2% as the year ended, started the week just below 1.8%. Gold, meanwhile, hit seven-year highs.

The thing that’s interesting to watch is crude. It got another lift Monday and scraped against four-month highs above $63 a barrel. As we noted back when crude got past $60, it has a lot of work to do to get to $70. If that happens, then maybe it’s time to get more concerned about possible market impact. At current levels, not so much.

For investors, it’s important to keep things in perspective and not be running scared, though it might be a good idea to take extra care until this all plays out. When that will happen is pretty much anyone’s guess, considering the U.S. and Iran have been putting out the unwelcome mat for each other since 1979.

Every sector except Real Estate and Utilities fell on Friday, and even Energy lost ground despite the rally in crude prices. It looks like the risk-off psychology has taken hold here, at least for now (see chart).

For some investors, the geopolitical instability might be providing an excuse to take a little profit from recent record highs, Briefing.com said. There also seemed to be less of an appetite for going long into the weekend, judging from a late flurry of selling in the closing minutes Friday.

Wait Until Friday

This week is a bit light on the data front right up until Friday, but things change in a big way that day as the government releases its December non-farm payrolls report. We’ll talk more about what people are thinking ahead of the numbers as the week continues, but it’s going to be hard to beat November’s impressive reading of 266,000 new jobs and 3.5% unemployment. Early analyst estimates point toward a sharp drop from the November job bonanza.

Jobs data follow the latest Fed minutes released Friday, which didn’t really contain many surprises. The Fed didn’t change rates at its December meeting, and Federal Open Market Committee (FOMC) members appear to believe current rates are in the right ballpark as long as economic conditions don’t change. It’s not exactly the kind of news that moves markets. 

From an earnings standpoint, homebuilder Lennar Corporation LEN reports on Wednesday, providing us a fresh look at the housing market. Things have been pretty strong for housing the last few months, fueled in part by low interest rates. New home sales have exceeded 700,000 in five of the last six months, the first time that’s happened since 2007.

Walgreens Boots Alliance Inc. WBA, the worst-performing stock last year in the Dow Jones Industrial Average ($DJI) and burdened recently by sluggish sales growth, also reports Wednesday. Analysts expect the company’s year-over-year earnings per share to drop.

Everything starts to light up a week from tomorrow when the big banks begin reporting. Forecasting firm FactSet said Friday it expects Q4 S&P 500 earnings growth to decline 1.5% year-over-year. That said, it expected a 4.1% earnings decline in Q3 and the actual was only 2.2%. Its expectations were also too negative in Q1 and Q2 last year, so let’s see how things develop. 

One stock bucking the downward trend Friday was Tesla Inc TSLA, which beat analysts’ Q4 delivery estimates. Unless you’ve been living in a cave since last fall, you’re probably aware that TSLA shares have been on fire lately, and the production data didn’t do anything to change that. Boeing Co BA shares came under pressure early Monday after reports over the weekend about more 737 troubles. 

Volume this week might get on a more normal path after two holiday-shortened weeks. A lot of trade desks were occupied by the “junior varsity,” if you will, over the last two weeks as many people went away for vacation. Now everyone is probably back at work. 

FIGURE 1: RISK OFF? News of an attack on an Iranian leader helped push gold futures (/GC - purple line) above $1,550 per ounce for the first time in nearly four months. The Cboe Volatility Index (VIX - candlesticks) also jumped on the news. Both /GC and VIX jumped again in the overnight hours. Data sources: CME Group, Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Emergency Descent? As we often see when Middle East tensions flare, travel and travel-related stocks jumped into the spotlight Friday after the U.S. killed Iran’s military leader. Airline stocks took a collective dive of 1% to 3% after the opening bell, right in sync with crude oil prices leaping 3%. Marriott Inc MAR, and Walt Disney Co DIS both retreated a bit, but American Airlines Group Inc AAL took one of the biggest blows with a nearly 5% plunge.

As one analyst on CNBC pointed out Friday morning, airlines have had a pretty smooth flight over the last couple of years when it comes to jet fuel prices, but now that’s being called into question. In addition to possibly higher fuel costs, many airlines face labor contracts that soon have to be re-negotiated, CNBC said. 

Defensive Positioning: One sector apparently benefiting from the overseas skirmish Friday was, unsurprisingly, defense. Raytheon Company RTN rolled up 1.5% gains while Northrup Grumman Corporation NOC gained more than 5% and  Lockheed Martin Corporation LMT stormed ahead 3.6% as investors appeared worried that the initial fisticuffs might get more serious. 

Unless things really accelerate very quickly and dramatically, these concerns might be overblown. What’s really front and center is the crude market, because most military analysts believe Iran was responsible for the strike on Saudi Arabia’s oil fields last fall and worry about the chance of more Persian Gulf oil-related attacks.

Even if none of this happens, continued tension in the Middle East probably bodes well for the defense industry because it means Congress is less likely to start rolling back armaments spending.

News From Near and Far: It’s amazing how a missile strike 6,000 miles away can have a bigger impact than a major data point for the U.S. economy, but that’s what seemed to happen Friday. Most market participants focused on the U.S. military attack in Iraq, and that might have masked the impact of a really disappointing ISM manufacturing report for December. In fact, on a normal day the market might have gone down even without the geopolitical tremors, because people would have likely focused on the soft number. As a reminder, the ISM manufacturing headline figure of 47% showed that U.S. manufacturing remains in a contractionary mode, and missed Wall Street’s consensus estimate of 49% The headline number missed the 50% mark (which indicates expansion) for the fifth month in a row.

Two things to keep in perspective: First—manufacturing isn’t a huge percentage of the U.S. economy any more. Second, the ISM report is a lagging indicator. Stocks are a leading indicator and have been on the rise. That could mean investors expect better economic data in the future, perhaps helped partly by lower rates and a weaker dollar. Time will tell.

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