With the possibility of military intervention in Syria in the news, it’s a good time to discuss why markets react to events that do not directly affect the NYSE or NASDAQ. Often, geopolitical events can temporarily affect both stock and bond markets, but long-term consequences must come from actual disruption of goods, services or commodities. Let’s use Syria as our example. This past week, the stock markets have moved on fear of worst-case scenarios. If you take out the possibility of another world war, that leaves a game of chicken among the U.S., Iran and Russia. The possibility of such events turning into a serious rift must be factored into stock, bond and commodity prices. Stocks would move downward if the flow of goods and services were disrupted, affecting earnings per share of companies that may have business in the region. We are talking about many companies here, too. Every country has Coca-Cola, toothbrushes, etc.
Cash would rush into the bond markets, especially U.S. Treasuries, considered a “fear trade” or a flock to quality. When people get nervous, they want something safe. High-quality bonds are considered safe, and given that the U.S. Treasury has never had a default on debt, global reserves tend to wind up here most often. Gold in this scenario would be another fear trade or a flock to safety as well. We have seen gold prices gyrate wildly recently based on a proposed Syrian military strike. When the times get tough, everyone likes gold.
The biggest question in the region is oil. Syria is not a major supplier, but its neighbors are. If the Saudis, Iran or Iraq are not affected, there should be no major disruption in Middle East oil supply. Luckily, the U.S. is no longer the biggest buyer of oil in the region. If a military strike does happen, keep an eye on the price of Brent vs. West Texas intermediate crude. The spread in oil could get dramatic if supplies are disrupted enough to cause prices to rise to more than the $125-per-barrel current resistance level. If oil goes higher, it could revisit the $150 level seen in 2008. You may also see light volume on exchanges prior to an actual decision or event in Syria. Why buy or sell if you can wait and see? Military events on a small scale typically spur is a sell-off on the rumor of intervention and rally on an actual strike. Of course, I am referring to no retaliatory actions from other nations occurring here. That is a different story that could cause severe sell-offs in stock markets everywhere.
So, what really drives market prices? Rising GDP and lower unemployment. These factors drive consumer spending, hence the prices of companies that provide goods and services rise. As for gold, inflation or lack thereof is the major driver. In this quarter, greater volatility may be tied to domestic events on the upcoming economic calendar. Fed tapering of bond and MBS purchases, along with another fight on the debt ceiling, are going to cause some crazy whipsaws even though we know these events are coming. Again, we may see a sell on the rumor and buy on the event taking place.
Even though war is always in the news, the globe is pretty peaceful compared with the 20th century. But no markets like surprises, and the outcome of a U.S. military strike in Syria is a big unknown. How markets will react will be based on outcome.
On another matter, I was in California when Bob Thomas passed away. Bob and I would get into some serious discussions about the Catholic Church and the business of building a successful company. I have a copy of one of his books. Bob was a good guy, and I will miss him.
Carol Perry is a retired financial adviser and has been a Northern Nevada resident since 1983. She can be reached at Carol_Perry@att.net.