The Market Is Getting Ahead of Itself

The ceasefire announcement this week provided a much-needed circuit breaker for global markets.

Ever since hostilities broke out in the Middle East, oil prices have been surging higher while the major indexes tumbled. Fears of inflation-fueled interest rate hikes (or an indefinite delay to any cuts, at least) saw the S&P 500 briefly skirt correction territory.

Yet after news of the ceasefire, the market recouped a big chunk of those losses. The S&P closed at 6878 on the Friday before war broke out (Feb 27). It closed Wednesday (the session after the ceasefire news) at 6782 – just 96 points lower.

In short, the war and potential instability ahead have just about been priced out of markets. But I remain incredibly leery.

History tells us there will likely be plenty of bumps ahead…

Will the Ceasefire Hold?

News of a ceasefire is positive, of course. But there’s no guarantee it will hold. The market is pricing in a best-case scenario – that things will continue to settle, oil will flow freely again, and stability will resume.

But people are already disputing whether Lebanon is part of the ceasefire equation. We’re getting ongoing reports of drones and other strikes across the region. Plus, there are conflicting reports on the contents of the peace plan… and which pieces have already been broken.

This fragile truce could fall apart. Plus, there are contradictory claims in play…

Despite Iran’s military apparatus being “obliterated,” Iran seemingly still has drones, missiles, and missile launchers hidden away. Despite its navy being “destroyed,” Iran still controls the Strait of Hormuz.

While some ships have safely passed through, it’s a trickle compared to normal traffic.

Then, beyond all that, there’s the debate about who’s running Iran and whether a “regime change” has really come into effect. And will Iran have to hand over its partially enriched uranium as a non-negotiable condition of any peace deal?

Each of these unresolved issues could trigger hostilities again…

Oil Is What Really Matters

There are a lot of factors up in the air. However, the one thing that ultimately matters for markets is oil.

Yesterday, Iran’s Revolutionary Guards provided an alternate route for shipping through the Strait of Hormuz to avoid hitting sea mines. But until global shipping companies and their insurers are satisfied that the risks are mitigated, they’re not going to allow ships to pass through the Strait.

That is going to keep a lid on supply.

We also need to account for the massive damage inflicted on oil and gas infrastructure across the region. That’s not something that can be brought back overnight.

The big correction in the oil price was welcome for the markets. Lower oil prices take some heat out of inflation fears and give the Federal Reserve some breathing room around interest rates.

But don’t trust that oil price problems are “solved” now. Even after the drop, WTI is still tracking around $90 – around 45% above prices in February.

And one more skirmish or attack on production facilities could push oil sharply higher once more.

That means we’re only one negative news headline away from markets going sharply lower again.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict