Bad Moon Rising

Economist Herbert Stein, who was chairman of the Council of Economic Advisers under Richard Nixon and Gerald Ford, is quoted as saying “If something cannot go on forever, it will stop.” For better or worse, it appears the Iranian nuclear program has reached that point.

It has always been U.S. and Israeli policy that Iran must never have a nuclear weapon. The only question was how that would be achieved. It appears we now have—or will soon have—our answer, as Netanyahu promises more strikes until Iranian capabilities are eliminated. But much like the current tariff issues, the outcomes here appear to be polarized: either Iran is coaxed into serious negotiations, or this is the onset of another Middle East war, which would likely drag the U.S. into the conflict. There isn’t much in between those outcomes.

The reaction in U.S. markets was rather subdued, presumably because the U.S. withdrawal of non-essential personnel from Middle Eastern embassies signaled that something was about to happen. In addition, Iranian oil assets were not targeted in the initial attack. Oil prices are up about 5% as this is written, but that increase is based on heightened risk, not a material reduction in energy output.

Prime Minister Netanyahu stated that Operation Rising Lion would last “as many days as it takes” and indicated that 14 days of strikes had already been planned. There was no assurance that Iran’s energy infrastructure would remain untouched at some point. As usual, there is speculation that Iran could close the Strait of Hormuz, throwing global energy markets into chaos, but we note that Iran also depends on the Strait to deliver its oil to customers, so we view that outcome as unlikely. We can only hope that cooler heads prevail and the ultimate resolution spares lives both today and well into the future.

What Might this Mean to the U.S. Economy?

That is a fundamentally unanswerable question at the moment, but we can speculate.

  • Oil prices pressure inflation higher: Even without Iranian energy assets being targeted, crude prices rose about 5% in response to the attack. Lower energy prices have been a key driver in keeping inflation under control, but that is conceivably off the table. Although oil prices are not up based on any fundamental limitations to supply, the additional risk premium added to oil prices on Friday is unlikely to ease soon. If Iranian crude supply is eventually disrupted, the price increases will be perceived as more permanent. That makes rate cuts less likely in the near term and complicates the Fed’s job of balancing price stability and full employment enormously.
  • Deficit spending to support Israel: Should the U.S. get dragged into this conflict, the inflation bogeyman looks even more imposing. Accelerated spending to support Israel would likely have the same impact as the Gaza war, that is, more deficit spending juicing the economy, pushing inflation higher and extending the national debt further than desired.
  • Sentiment Likely to Fall: Obviously, stock market sentiment is likely to be impacted, but consumers can be impacted too. There is little immediate evidence of that, but if the conflict should lengthen, we would not be surprised to see both the stock market and consumer sentiment take a step back.
  • Flight to Quality: Normally, such events would begin a ‘flight to quality’ in financial markets with the dollar and gold rising and interest rates declining. We actually saw little of that on Friday, with rates moving slightly higher, not lower and the dollar rising modestly. Gold, however, is up about 1.25% as this is written.
  • The Fed has a developing problem: Rising inflation, potentially combined with a consumer pullback, would spell trouble for the Fed in implementing its mandate of price stability and full employment. The Fed can’t defend price stability in an inflationary environment and support jobs in a weak economy at the same time. The policy prescriptions are fundamentally at odds with each other. It begs the question: which would take priority if such a situation should occur?

We appear to be at a point we hoped could be avoided. Nonetheless, it means little for our portfolios. We will stay invested because we own companies that will generate growth and cash flow no matter the path this crisis takes, and that is what will determine value in the long run. Another correction here would take some of the excess speculation out of the market and allow new cash to be invested. These are all normal and important things, even if the cause is anything but normal.

Happy Father’s Day!

 

What We’re Reading

 

Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

 

, , , , ,

General News

By: Adam