The day dawns with stocks perched at all-time highs but geopolitical tension still pulsing. Any Middle East or tariff headlines could potentially end up determining the action.
Figure 1: BACK ABOVE THE CLOUDS: It’s been a stormy three months for the S&P 500 Index (SPX), as this chart demonstrates. It’s gone from all-time highs to four-month lows and back to new all-time highs again. The question is whether it can stay long at these lofty levels. Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Greenback in the Red: After the Fed sounded dovish on Wednesday, the dollar index fell nearly 1% over the next 12 hours. This retreat comes after the dollar galloped to nearly two-year highs earlier this spring amid global economic worries that seemed to lift demand for so-called “defensive” assets like gold, Treasuries, and the greenback. Gold also recently hit a nearly six-year high, and as we’ve seen, 10-year Treasury yields fell below 2% this week for the first time in two and a half years.
Now the dollar now appears to be playing defense in the wake of the Fed’s words, falling to well under 97 on Thursday from highs above 98 less than a month ago. The softer dollar—if it lasts a while or falls further—might be good news for U.S. firms that depend a lot on overseas revenues, especially Industrial and Technology companies. A muscular greenback has hurt their earnings a bit recently, but lower rates might mean some relief, along with a possible boost to overall S&P 500 earnings per share growth. Still, let’s not get ahead of ourselves. The dollar would have to probably fall below 95 and stay there for a while to start having a major positive impact on earnings for multinationals.
Watching “Risk Assets” As Middle East Worries Percolate: On the other hand, if tensions grow in the Persian Gulf, the dollar might possibly be a beneficiary. An international crisis often sends investors fleeing into areas of the market they see as “safer,” though no investment is truly “safe.” This can sometimes include the dollar, the Japanese yen, gold, and U.S. Treasuries. Treasuries have already rallied fiercely over the last six months, but with 10-year yields falling below 2% this week for the first time since November 2016, it’s unclear how much runway the Treasury rally might have left. Gold hit $1,400 an ounce this week, a level it last touched in late 2013.
If tensions grow over the weekend, it’s probably worth watching gold and the dollar, as well as crude. It goes without saying that crude is the main market indicator of stress in the Middle East, and its sharp rise Thursday offered more evidence of that. Volatility—another so-called “risk” meter—also started to see some bidding, with the Cboe Volatility Index (VIX), up 7% by midday Thursday to near 16 after falling below 15 earlier this week. That’s still below the historic average for VIX, but some investors who hadn’t bought VIX futures in a while apparently started to find them interesting again this week. However, VIX pulled back later Thursday to under 15 again when it looked like tensions in the Gulf might be defusing slightly.
Defense on Field: The aerospace and defense sector, led by BA, Raytheon (RA), and Lockheed Martin (LMT) took a ride up the escalator, climbing 1.2% Thursday as tensions with Iran ramped up. LMT and the others have performed well lately, though some of that might reflect the weaker dollar as much as any geopolitical worries. These companies tend to be barometers of military spending, so any international touchpoints can give them a boost. Then there was the recent announcement of a planned merger between United Technologies (UTX) and RA, which raised hopes for more merger and acquisition activity in the defense sector. The next key date in the Iranian situation will be July 7, Barron’s reported. That’s when Iran will decide if it continues to go by the terms of the 2015 nuclear deal, which President Trump exited.
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