Of Giants, Growlers and Gargoyles (aka Missiles and Markets)

We live in interesting times.

For a short while it was the Trade War with China. Suddenly Wall Street is worried about Real War. Which of course gives me a very rare opportunity to..errr..combine three of my interests: weapons, geopolitics and finance!

Incoming!

Post the alleged gassing of his own people by Assad, POTUS warned Assad and Putin, his loyal ally, of an American attack. Not via land invasion (way too risky) or even an aerial bombardment (still too risky). But a safe, stand-off attack via a barrage of ship-based missiles, courtesy of the USS Donald Cook and the USS Porter, both of which are Arleigh Burke class guided missile destroyers, each carrying 60 tomahawks, a subsonic cruise missile made by Raytheon.

The only systems in that area that can shoot down the Tomahawks are the S-300 and S-400 Surface to Air Missiles (“SAMs’) owned and operated by Russia. NATO has a colorful coding system for these SAMs so the many variants of the powerful S-300 family have been bestowed with curious names; Giant, Growler, Gargoyle, Gladiator et al. Now these SAMs are unique; they are fully mobile beasts that can target aircraft and ballistic missiles, track targets 300km away, fire against 12 targets simultaneously and fire rapidly (two missiles every three seconds) up to a range of 150 km and an altitude of 30 km. The Russians brought these beauties to Syria in 2016 to protect their bases in Tartus and Latakia but these can easily be used to shoot down Tomahawks IF their bases are threatened.

The US could destroy these Russian SAMs. But that is very risky as it can kill Russian soldiers and take the conflict to another level. And these two adversaries are masters at deescalating, thanks to 70 years of post WW2 experience.

So, expect some sabre rattling. But let’s just say there’s too much at stake for the cold war foes to attack each other.

Markets

Let’s now cast our eyes on the exciting action in another area; financial markets. U.S. 10-year yields were down at 2.762% as investors flocked to haven treasuries. Stocks swooned as expected. 

But look back at history and you begin to see a pattern.

Strikes and stocks

Most military conflicts have triggered (pun intended) a pattern in the stock market: stocks fell from when the US committed to action until action began; once action began, markets rebounded.

Example # 1: First Gulf War. Stocks bottomed on January 9, 1991, just days ahead of the January 17, 1991 start of the war. The related 6% decline that began in mid- December 1990 was fully recouped in the following six trading days. Example # 2: Second Gulf War. Stocks bottomed on March 11, 2003, just days ahead of the March 19, 2003 strike and subsequent invasion of Iraq. The related 13% decline that began in mid-January was fully recouped in the following 38 days.

Stocks tend to rally whenever the U.S. starts an attack. It doesn’t mean that investors like war. It’s just that they dislike uncertainty, and that’s what’s typical in the weeks prior to a US attack. Much of that uncertainty gets sorted out soon after U.S.-led hostilities begin.

Volatility and Prices

That’s not all. A 2013 study found that the stock market’s average volatility was significantly lower during four major wars of the last century: World War II, the Korean War, the Vietnam War, and the first Gulf War. And not by a small bit: Large-cap stocks were 33% less volatile while small-cap stocks were 26% less volatile.

And prices were higher! Large-cap stocks gained 1.4% more per year during these four wartime periods than the rest of the time, while for small-caps, the margin was 2.2%.

End piece

The big concern is: will this strike broaden into something nastier? Will Russia retaliate and make this something more? If the strikes are quick and surgical the negative effect on stocks may not last long. The market usually shakes off Geopolitical risks not just because these are mostly localized and short term but also because after a long time the global economy is finally in synchronized growth mode.

Plus, it is the season to cheer! The Q1 earnings are around the corner and today a few banks (JPM, Wells Fargo, Citigroup) will release their earnings. Any good tidings may give markets the much-needed lift. And you may want to look at Raytheon stock; they make the Tomahawks and sell ‘em for USD 1.9 million apiece!

What really matters

Markets are often short sighted. Investors should be more focused on long-term issues.

Like a burgeoning Trade War, out of control inflation, strict regulation of the tech sector, the inverting yield curve and let’s not forget the twin US deficits totaling a whopping 6% of GDP, thanks to tax cuts and extravagant Govt spending. And if that wasn’t enough there is the Trump factor which means the Russia probe, Stormy Daniels and a fast approaching Mueller leading to POTUS being hobbled or even impeached.

All or any of which can bring down markets faster than any Growler or Giant!

Expect a rocky 2018.