By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
The killing of Iran’s Major General Qassem Soleimani in a US drone strike on Baghdad International Airport is a world historical moment, akin to the USAF hit on the Imperial Japanese Navy’s Admiral Yamamoto (Mr. Pearl Harbour) or the SEAL team’s execution of Osama bin Laden (Mr. 9/11). General Soleimani was the second most powerful man in an Iranian regime strangled by the “maximum pressure” sanctions of the Trump White House and its spymaster in Iraq, Syria, Lebanon and Yemen. Brent crude oil has surged to 69.50 a barrel and gold is $1549 an ounce as I write. This means the financial markets believe the Iranian general’s killing is casus belli for Tehran and Washington, possibly via another attack on the US or its allies in the Gulf – and Iraq could well be ground zero in this new proxy war. This could be an Austrian Archduke Franz Ferdinand black swan moment in the Middle East – expect asymmetric warfare (terrorism), attacks on oil tankers in the Straits of Hormuz, Iran sponsored militia attacks on US military bases in Iraq and tensions on the south Lebanese/Israeli border.
The Trump White House and the theocratic regime in Qom/Tehran do not want to fight a full blown war in 2020. Iran is bankrupt as its oil exports have plummeted to a mere 250,000 barrels and Trump’s Republican voter base is disgusted with the trillion dollar costs and blood sacrifices of the protracted wars in Afghanistan and Iraq. Yet a rise in the geopolitical risk premium of crude oil is inevitable – Brent at $78 is now all too possible and I accumulate energy, Russia and gold assets – a strategy I have advocated ad infinitum in this column since late 2018. Short term bearish ideas? Sell Bank of America (lower Uncle Sam yields) and Salesforce.com (100 times earnings, high beta) and oil consuming emerging markets with political instability risks (India, Turkey). Currency trade ideas? Long Russian rouble or the Norwegian kroner against the Turkish lira as a hedge once US Tomahawk missiles fly like angels of death over the ancient Persian desert. Oil price spikes and high terrorism risk is also leprosy for airlines, as the 6% plunge in Air France-KLM and Deutche Lufthansa suggests. Sectors that will benefit from a potential hot war between the Great Satan and Axis of Evil? Offshore oil drillers (RIG), missile vendors (Boeing’s Hellfires, Raytheon’s Patriots) and cybersecurity/battlefield intelligence stocks (must remain classified LOL).
2019 was the year it rained money on Wall Street. The S&P 500 index was up 30% and the NASDAQ Composite was up a stellar 40% plus, a testament to the fabulous valuation re-rating of Silicon Valley’s megacap FANG gorillas. My conviction call on Microsoft shares, published when Mister Softy traded below 100 in December 2018, is now up a fabulous 60%, making Satya Nadella my favorite CEO on Planet Money. What next for Wall Street equities? Apple meteoric ascent is my biggest dumbo move of 2019. The US market is expensive at 18.5 times forward earnings, up from 15.4 in late 2018 when I saw a classic buy opportunity the moment the Powell Fed lost its nerve and signaled a monetary policy U-turn (easy money) to the financial markets. It is essential to be nimble in sector rotation and index hedging profits in 2020 as a rising macro tide will not lift all boats in the constellation of risk assets. The Relative Strength Index on the SP 500 is now 79, a classic proxy for a grossly over brought US stock market index.
What are the subliminal messages from Mr. Market in January 2020? One, Wall Street is confident that President Trump will survive the impeachment process, win the Republican Party’s nomination and win reelection in November 2020. Online prediction markets give 50-50 odds on Trump winning reelection against any Democrat opponent. This now consensus on Wall Street and any event that hits this consensus will gut the psychological ballast (Lord Keynes’s “animal spirits” of the current bull market). This is why I believe the Presidential race’s early primary season will be a period of maximum near term risk for the US stock market. If a regulate, tax and spend Democratic candidate like Senator Bernie Sanders or Elizabeth Warren wins the nomination, let alone the election, expect a swift, brutal sell off on Wall Street. Even if Joe Biden wins the Democratic Party’s Presidential nomination, I expect the S&P 500 index will take an immediate 8-10% hit. US domestic politics, let alone the energy geopolitics of the Middle East, remain a wild card in the US stock market in 2020.
Two, I expect the post-Iraq airstrike surge in Brent crude to add to angst about rising wage inflation in the US stock market. This leads me to two macro conclusions – gold will continue to rise to my $1650 an ounce target and the yield on the ten year US Treasury note will rise to 2.40% in 2020. As safe haven capital flows into US Treasury bonds unwind on hopes of a US-China trade deal, I expect the US Dollar Index to fall to at least 94. The SP 500’s dividend yield is a pittance at 1.70% and a 2.50% ten year US Treasury bond yield will trigger a selloff in equities as fund managers rotate into fixed income. The Powell Fed indicated at the December FOMC that it will only respond to “significant and persistent rise in inflation” – this means an inflation risk premium in ten year US Treasury bonds will only increase and its yield, 1.85 as I write, will surge as high as 2.40 and trigger a global bond market bloodbath.