9/4/2013 6:15 PM ET|
Why Syria scares the market
The specter of a military intervention in a volatile region is bad enough. But the aftermath could hit the economy right where it's most vulnerable.
The market has been preoccupied with the situation in Syria -- and the surge in crude oil prices that has resulted from fears that an American strike, in retaliation for an alleged chemical weapons attack by the Assad regime in Damascus, could open a Pandora's box.
President Obama, after much saber rattling last week, appears well on his way to securing congressional support for strike authorization with prominent Republicans lining up behind him. The French are still with us. The Israelis are flexing their muscles. But the Chinese and the Russians remain steadfast in their opposition to action, Syria has threatened to retaliate, Iran is a wild card, and global oil output is already constrained because of supply disruptions in Libya.
The result: Benchmark West Texas Intermediate crude oil is pushing towards $110 a barrel, a level that's been breached only briefly over the last five years. If the tomahawks start flying, we could easily see a retest of the 2008 highs near $145 a barrel and a surge of inflationary pressure.
Here's the kicker: Higher inflation is this economy's kryptonite. It would undermine a rebound in consumer confidence and threaten the ability of central banks to bolster markets with their cheap-money stimulus. Without that support, things would get messy fast.
Here's what investors need to watch and a couple of ways to play oil.
A frantic fall
Even before the Syria situation blew up, the autumn was always going to be messy, as big unresolved catalysts from which investors had enjoyed a reprieve were set to return.
We've got another round of budget fights in Washington as the Treasury is set to hits its debt limit in early October. The political catfight over taxes and spending will resume within just days. The threat of a possible government shutdown, credit downgrade and/or default on the nation's debt will keep investors worried.
We've also got that long-awaited decision from the Federal Reserve, which has been hinted at since May, on whether or not it will taper its ongoing $85 billion-a-month bond purchase stimulus program. Clearly, the economic data is getting better, with a reacceleration in global manufacturing activity and U.S. GDP growth, which might lead the Fed to dial back stimulus.
But nagging concerns over a surge in interest rates (caused by all the taper talk), the budget fight, Syria and some softness in the housing market has led many to believe the Fed will hold off until December.
The way the market has freaked out, and the way the bond market has been roiled, shows how important the Fed is these days.
There are other catalysts to worry about, too, including an upcoming election in Germany and the possible need for another Greek bailout.
All about the black stuff
Head-and-shoulders above all that now is the specter of open war in the Middle East, as a possible U.S. strike threatens retaliatory attacks by pro-Syrian forces allied with Hezbollah and Iran and armed with Russian anti-ship missiles and long-range rockets.
The problem is that these tensions are happening at a time when oil prices are already high because of the rebound underway in the global economy (shown by the gains in the manufacturing Purchasing Manager's Index data gathered in the chart below, taken from an analysts’ report), some recent weakness in the U.S. dollar and a shuttering of output in Libya and elsewhere. There's currently a global supply shortfall of around 4 million barrels per day, according to Societe Generale analysts. (That's how far below full potential output we actually are.)
Libyan production is down to around 400,000 barrels per day, well below the postwar highs of 1.5 million barrels. Iranian production is at 2.7 million barrels per day, down from 4 million barrels in 2007 as economic sanctions against Tehran's nuclear program bite. Iraqi production is below 3 million barrels from 3.2 million in April.
Maintenance at Iraq's southern Basra export terminal this month is expected to knock out another 500,000 barrels per day of supply. And what's worse is that North Sea production, which could've provided some relief to supply disruptions in the Middle East, is running at nearly one-half the level of production seen in 2008 due to maintenance stoppages.
If the attack on Syria goes forward, the only hope for run-rate relief in the oil market will have to come from Saudi Arabia, which maintains the vast majority of the world's spare oil production capacity. Production there is already up around 800,000 barrels per day from late last year. It's an open question how quickly additional supply could be brought online.
Bank of America Merrill Lynch analysts estimate that the Saudis maintain a spare capacity cushion of around 2.4 million barrels per day. Societe Generale puts it at 1.7 million barrels. Whatever the number, much of it will take time to bring back online as idled fields are restarted. It's not like flipping a switch.
Another option would be a release of oil from the Strategic Petroleum Reserve, which holds 1.6 billion barrels of oil and was tapped for 30 million barrels during the Libyan conflict in 2011. And we also have the benefit of steadily increasing U.S. production: Thanks to fracking technology, production has been growing at a year-over-year rate of around 1 million barrels per day since the middle of 2012.
The real risk is inflation
The reason the S&P 500 ($INX) was able to surge above 1,700 in August, and the reason the economy has been slowly gaining momentum, is that inflation has remained docile enough for the Fed to keep pumping cheap money into the system -- at a pace that exceeds what was happening in the depths of the financial crisis -- despite the fact the recovery is now in its fifth year.
You can see that in the way the Fed's preferred inflation gauge has indicated an annual inflation rate below 2% since early 2012, as shown below.
The risk here is that an attack on Syria would throw gasoline on the sectarian civil war there, which could spill over into Iraq and heighten tensions between the Shiite and Sunni Muslims. Syria isn't a major oil exporter -- it produces only about 50,000 barrels per day -- so the severity of the impact will depend on what happens elsewhere in the region and the severity of any retaliatory attacks.
If sectarian tensions crimp Iraqi oil output, Societe Generale analyst Michael Wittner believes oil prices could hit $150 a barrel -- which would represent new all-time highs. Merrill Lynch believes a $160 per barrel level would be in play if U.S. ground troops get involved.
Any sustained increase would force the Fed to taper sooner, as inflationary pressures spiked. Consumers would likely retrench in response and suck the wind out of the economy, while financial markets would fall into turmoil as the promise of easy money -- which has bolstered stocks since 2009 -- is suddenly and violently removed.
Consumer and transportation stocks would take the brunt of the damage while oil and gas producers could remain relatively buoyant.
How to invest for the uncertainty
The situation is obviously quite dynamic, so my advice to investors is to remain cautious, raise cash where possible, and avoid exposure to areas such as airlines that would be directly affected by a rise in oil prices and a loss of consumer confidence.
The market is at a key technical decision point, as it rests right at its June low. A breakdown here would quickly put the February trading range -- around 14,000 on the Dow ($INDU) -- back in play. That would be another 5% decline from current levels.
Yet the market is also quite oversold and poised for a relief rebound driven by, for example, a "no" vote on military intervention in Syria by Congress. You can see this in the way the relationship of new highs and new lows on the NYSE has fallen to levels associated with past turnarounds, as shown below.
Investors face a tricky situation as kids go back to school, a chill returns to the air, and the warmth of summer fades away. With so many hurdles to clear, a mixed technical outlook and a market vulnerable to a 5% move in either direction, a neutral positioning is the best bet here with a focus on preserving your portfolio, not scoring big profits.
Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at firstname.lastname@example.org and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
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Waterboy you are dead on....... I've been screaming at the radio for someone to bring up that very irony.
The screwballs who are all for going into syria because of chemical weapons are the SAME ones that wanted Bush brought to the Haig for war crimes because they didn't find chemcail weapons.
Every nation's intelligence confirmed weapons in IRAQ but we gave 'em what, 6 or 8 weeks of warning that we were coming. During that time there were convoys observed headed for syria. Their airforce tried to escape to syria, There were cargo ships mentioned in the news that went to syria. What the hell do people think was being transported???
The worst part of this is the publics short memery and the inability to connect the dots.
The real question, how many new Schools could be built here instead of feeding money to those that profit off of Wars? The risks in Syria are simply not worth any future rewards. Those that vote to get involved, should be voted out in 2014. That's the only thing, DC truly understands.
Big Oil and those same players in the Middle-East, make out like Bandits, each and every time, the War Mongers play their games. Anthony again points out the obvious, after the fact. Rising Crude Prices will have a far bigger impact on the economy than what we currently expect in the near term for interest rates. In the end, it's the working poor and Middle-Class that will get hurt the most. Same old same old.
Think the Market is more scared of.. Mr. Nobel Peace Prize.. winner.. oblamos Red Line Stance than what happens in Syria...Syria is NOT PART of The USA..And oblamo needs to stay the hell Out..
The American people are tired of unsubstantiated claims by this administration on the facts of world events ! Benghazi was a terrorist attack- Kerry, H. Clinton, Obama still won't admit this. 'Fast & Furious' put heavy arms into the hands of the drug cartels- A.G. Holder still will not admit this.
I could point out others, but the point I'm making here is:
WE WANT PROOF NOW- NOT CONJECTURE !
Even though Russia has the veto powers in the UN, I think that they'll go along with the security counsels decisions to go into Syria-Putin has already said as much. But they need to verify WHO USED chemical weapons- I'm suspecting Al-Qaida elements within the resistance did this to draw us into a conflict that can better be addressed if the whole world (UN) is involved.
I know it may be harsh, but lets keep the fighting contained inside Syria- let them kill each other- less problems for us down the road- do we really want to send our sons & daughters into harms way to intervene in what brand of Islam they want to practice? I could care less about that reason- in fact, that being the main cause of this civil war, all the more reason for UN support. If the UN fails to act- dissolve the UN-make our case to our allies and then go after Assad.
Saudi Arabia has Obama in their pockets. They want Syria taken care of and are using their puppet to push to make sure it gets done.
All the while working class gets screwed more by high gas prices and Saudi and puppet politicians get rich. Let the middle east pay the politicians since they work for them!!! When is the last time a politician got in this big of an uproar about anything in the UNITED STATES?!!!!!!!!!
One article says Libya will not affect gas prices and every other article states that the reason for high oil prices is Libya and as always the word "IF" is involved.
Brings the meaning of "BAFFLE THEM WITH BULL$HIT" to a whole new level.
Nice try but we know the truth.........WORKING CLASS IS SCREWED!!!!!!!!
I can't imagine why yet another US invasion of a sovereign nation would 'scare the markets.'
Perfect chance to bring profit....er....democracy, I mean, at the expense of poor people. I should think all the capitalists would be buying up Haliburton stock and just licking their chops.
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