End of the year rally?
It amazes me that the end of the year is just right around the corner.
It always goes by so fast. I am blown away to think that our youngest daughter will be one in a couple of months.
But there is so much to look forward to. Cooler weather, family gatherings, and good eats are upon us.
In addition, the 4th quarter tends to be a seasonally stronger period for the capital markets.
I know many of us would welcome a market rally after a year of new/expanding wars, tough economic conditions, and other catastrophes.
But, will we get one?
For starters, the devastating attacks and the geopolitical events in Israel do not help make a positive case.
I'd like to note that "geopolitical event" is a very antiseptic phrase for horrors like bombings, wars, invasions, and other terrible attacks, and really fails to encompass the full cost of human misery.
The start of this conflict has already cost thousands of lives and has the potential to profoundly affect the region.
While the violence might seem far away, behind every headline are real people, families, and communities that will never be the same.
My heart is heavy by the catastrophic impact this has had on many families. Our hearts go out to all of the loved ones lost and to those who are suffering through these events.
We pray and hope for a speedy solution, although it does not seem that this will be the case.
How do geopolitical events affect the US economy and capital markets?
Israel has a key position in the region, it's highly likely that we'll see energy prices impacted by the conflict, which has the potential to increase inflation.
Couple this new war with the ongoing war in Ukraine, and OPEC production cuts, a large and growing demand for oil and gas products is adding to renewed upward pressure.
Source: www.finviz.com
As you can see in the chart above, Crude Oil (WTI), has risen from roughly $16 a barrel since July and is expected to continue as supply is having trouble with keeping up with expanding demand.
As the demand for oil increases, many are concerned that a second wave of inflation may be on the horizon.
This fear can be seen in the continued move higher in interest rates despite the Federal Reserve’s decision to keep interest rates unchanged in their September FOMC meeting. (See chart below)
Interest Rates
If we remember, rates are not fully dictated by the Fed. The Fed does have the ability to set a target rate on the overnight interbank lending rate which does influence rates; however, the true determiner of rates is supply and demand (i.e market participants and debt issuance).
As treasury bonds are sold by investors and other countries, or as new issues hit the market, interest rates will rise. More so if the demand for that debt cannot be absorbed.
Expanding wars will only exacerbate this debt as we continue to offer aid in the form of equipment, support, and financing.
Our government has issued more than $1 trillion in debt over the last 3 months alone.
Conclusion
Before the news of the war in Israel, the US economy, although battered, seemed to be on a little better track and now is coming into question.
Many investors are concerned that higher prices in oil, renewed inflation, and high issuance of debt will continue to push interest rates higher until something truly breaks.
The silver lining here is that although geopolitical events may bring unwanted volatility to our portfolios, history shows they are relatively short-lived.
In a recent study of market performance following 29 past geopolitical events, the stock market was up 66% of the time just one month later.
In addition, the debt market may be doing the inflation fighting job of the Fed, as rates continue to rise, without the Fed’s hand.
Of course, some volatility should be expected in light of the recent news, but as long as we do not see a significant rate of change to the upside in rates, despite possible short-term volatility, a market rally is not out of the question.
As always, I am watching and I'll reach out with more information as the situation develops.
For now, let's hug the people we love extra tightly today and look forward to the holidays ahead.
“Waiting helps you as an investor and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.” - Charlie Munger
Thank you for reading,
James Anadon
References:
https://www.crfb.org/press-releases/national-debt-reaches-33-trillion-adds-1-trillion-debt-3-months
https://www.reuters.com/markets/asia/live-markets-what-history-says-about-geopolitics-market-2022-02-18/
Charts:
