Larry Adam: Several Dynamics Could Impact Economy and Markets

by Larry Adam, Chief Investment Officer, Raymond James

Key Takeaways

  • American lives lost remains Trumpā€™s ā€˜red lineā€™
  • Domestic attack would impact ā€˜braveā€™ US consumer
  • High oil prices would take away spending ā€˜freedomā€™

The fact that today marks the 100th anniversary of the inauguration of the League of Nations is evidence that world peace has always been top of mind for global leaders. Formed in the aftermath of World War I, the League was created to foster and promote the principles of international cooperation, peace, and security. While it could not prevent World War II, its successor organization, the United Nations (formed in 1946) has prevented another devastating, worldwide, large-scale military conflict from occurring over the last 75 years. However, peace has not been perfect, as it has been interrupted by multiple regional wars (Vietnam, Korea, Iraq, etc.), skirmishes (North Korea, Syria, etc.) and acts of terrorism.

For the most part, the recent geopolitical risk events have had limited, if any, impact on the financial markets. In general, the more isolated the actĀ  and the further from the US the act occurs, the less impact the event has had on the markets. Even the recent escalation between the US and Iran, where top Iranian general Qasem Soleimani was killed by US forces and Iran orchestrated retaliatory attacks on US bases in Iraq, has not had a dramatic impact on most asset classes. While we are not surprised by the limited market moves so far, we outline several dynamics below that could lead to a more dramatic and sustainable impact on the economy and financial markets.

  • American Lives Lost | President Trumpā€™s administration has been quite clear that any US casualties are the ā€˜red lineā€™ in negotiations with Iran, and whether it was attributable to US intelligence, advanced warning from the Iraqi government, or Iran intentionally aiming to miss, the retaliatory attack on Iraqi bases housing US troops resulted in no American lives being lost. President Trump was able to characterize Iranā€™s counter actions as ā€œstanding down,ā€ which allows him to pursue other tactics such as increased coordination with NATO and the European Union and harsher economic sanctions in order to manipulate Iranā€™s future behavior. While it remains our base case that there will be no imminent retaliation by US forces, we believe President Trump touting the revamped power and might of the military was an attempt to dissipate any lingering threat as well as provide a warning of what could come should US military personnel or American citizens be harmed.
  • Attacks on the Land of the Free | Any calculated, grand-scale attack on US soil would prove to be a tipping point in our relations with Iran. As weā€™ve mentioned, the market reaction to geopolitical flare ups overseas is rather subdued in comparison to domestic attacks. But even beyond the immediate market reaction, any attack that evokes widespread fear amongst the American people (i.e., September 11) would be detrimental to the US economy. The US consumer has and continues to be the primary driver of US economic growth, currently accounting for ~70% of GDP. If consumers become concerned about purchasing tickets for events (concerts, sport competitions, art performances, etc.), traveling within the US or abroad, let alone visiting their local mall, consumer spending and economic growth would certainly be impacted.
  • Paying More At The Pump | While the US is the top oil producer in the world, it is also the top consumer, and for specific grades and for certain regions of the US, it is still more cost effective to import oil. Since ~20% of the global oil supply is transported through the Strait of Hormuz, the escalation in tensions at the beginning of this week sparked fear that Iran may completely shut off crude supplies, which would result in a spike in oil prices. If oil moves sustainably above $70/barrel, it would equate to a $3.00/gallon price at the pump, which is a key psychological level for US consumers. In the past, oil prices at or above this threshold translated into a decline in consumer spending on discretionary goods and services.
  • Cyberattacks Curtailing Consumer Confidence | Of course, President Trumpā€™s main concern remains the safety of US troops and American citizens. However, a cyberattack that disrupts communication resources, the financial systems, or the power grid would be damaging to the US economy and psyche despite no lives being lost. An attack of this nature would reveal the vulnerabilities of a service-oriented economy, and cause consumer confidence to waver.

Our most recent Investment Strategy Sentiment Survey suggested that only 10% of respondents were concerned about geopolitical risks. Therefore, the greatest market risk related to the above security threats is that these possible outcomes are not currently priced into the equity market, which means any protracted event could lead to a more substantive pullback.

 

Chart of the Week
Click here to enlarge

View as PDF


All expressions of opinion reflect the judgment of Raymond James & Associates, Inc., and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risk including the possible loss of capital. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. Past performance may not be indicative of future results.

 

 

Copyright Ā© Raymond James

Total
0
Shares
Previous Article

Tail Risks Rising, Iranā€™s Economic Misery, and 737 MAX/Min

Next Article

Capital Markets Desk: Active ETFs, Small ETFs and Other Trends to Watch in 2020

Related Posts
Subscribe to AdvisorAnalyst.com notifications
Watch. Listen. Read. Raise your average.