On Tuesday, the S&P 500 closed out a spectacular 2019 without incident and officially posted a 31.5% total return for the year. However, after a solid first day of 2020 that saw recent trends holding firm, markets were disrupted by a shockwave of geopolitical tension emanating from the Middle East. News hit the wire that the U.S. had killed a top Iranian military official in Iraq, stoking fears of retaliation and further devolution of relations between the adversaries. Oil soared and bonds rallied, but equities seemed to take the news in stride. With such a nasty headline, a decline of only .71% is admirable. With some digestion, the market is calculating that all-out war remains a very remote possibility.
Tensions between the U.S. and Iran are certainly near or at an all-time high following this week’s incidents. Iran is on the ropes because of crippling sanctions and they have become desperate to exert their influence anywhere they can and they have become a thorn that the U.S. can no longer ignore entirely. However, it’s important to remember that we are living in an era of U.S. energy independence. The U.S. has much less interest in the Middle East as a whole and is not advocating for regime change. Another full-scale conflict is the last thing this administration wants. On the Iranian side, they too have little appetite for a full-blown conflict that could be their ultimate undoing. So we are most likely left with a continuation of the proxy conflict narrative that has played out over the last decade. It may scale up some, but is unlikely to threaten the global order. Oil prices may push higher for a bit here, but ultimately global supply and demand should be largely unaffected by the escalating tensions.
With such a strong run to close out 2019, the market may be using Iran as an excuse to consolidate. There are good levels of support in the 3080 range and a fall back to these levels would be normal and even healthy. The solid foundation laid at the end of 2019 is still well intact. The Fed is on hold, global growth is moderately improving, and a “Phase 1” deal is on the horizon. This matters to the market far more than Iran and will ultimately be the driver for 2020. If these items can translate into an upside surprise for economic growth and earnings, the market has more room to run in the year ahead.
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