The new year has been marked with severely increased tensions between the US and Iran, forcing many investors to increase their allocations to safe-haven assets such as Gold, the Japanese Yen and Swiss Franc. That shouldn’t be a surprise given that the search for “World War III” reached a record high on Google trends over the last week. Oil also experienced volatile moves, but the action was short-lived after the geopolitical situation de-escalated. Traders monitoring the developments may have profited from the volatile price action, but long-term investors who moved to a more defensive position have lost the opportunity after a strong rally in equity markets in the latter part of the week.
With Brent prices falling back below $65, traders seem convinced that Iran will not block the Strait of Hormuz or carry out attacks on shipments. That’s because Iranian exports to China are a significant source of the government’s revenue and without it, the economic crisis will only exacerbate. President Trump has also backed away from military confrontation, as increased tensions in the Middle East and higher Oil prices will hit both consumers and businesses which is the last thing he wants before the November Presidential Election.
A 10% correction in US equity markets can never be completely ruled out, especially given the rich valuations. But with the Fed and other central banks increasing asset purchases and pumping in more liquidity, they are putting a floor to prices and directing investors toward risk assets. The latest US jobs report, despite missing headline expectations and wage growth, is still the best formula for a further rise in equities. The US economy continues to add enough jobs to absorb new entrants to the workforce, and with year-to-year wages dropping to 2.9%, the Fed can be relaxed that inflationary pressures are still far away, suggesting no imminent need to tighten monetary policy.
Investors will now turn their attention to the fourth-quarter earnings season that gets under way this week when JPMorgan Chase, Wells Fargo and Citigroup report on Tuesday. According to Factset, year-over-year earnings are expected to decline 2% for S&P 500 companies, while revenues grow 2.6%. However, the forward outlook for 2020 is brighter than last year with earnings expected to grow in the high single digits.
Wednesday should see the signing of the “phase one” US-China trade deal. While much of the positive news has already been priced in, some details may still move markets either way. However, the most important factor in this deal is that the US and China are heading towards de-escalation in trade tensions and not the opposite way around.