Market turbulence has returned with a vengeance in April. The Iranian attacks on Israel triggered more volatile price action to start the week. I covered the issue on Monday. The advanced notice that the attack was coming was an important signal that Iran does not desire an escalation. After days of uncertainty, Israel responded Friday morning. Geopolitics are as tense as they’ve been in quite some time. The Market is finally paying attention.
Israel launched a missile strike on an Iranian military base in Isfahan overnight. The scope and scale appear to have been limited, and Iran itself has downplayed the damage. Our sources interpret an effort by both parties to back away from further escalation. Remember, Iran threatened retaliation for even the “tiniest act” last weekend. Tehran called this military response a failure. It appears Israel carefully calibrated this retaliation which, so far, is not stoking fears of a major escalation. There are indeed early signs that the symbolic nature of both actions could open the door to de-escalation. If both sides call it a victory, it would be a big step towards a cooldown.
For Iran’s leaders, standing up to Israel and projecting strength helps boost their popularity after months of protests over worsening living conditions and the weak economy in the Islamic state. On the flipside, the direct conflict with Iran has increased Israeli Prime Minister Netanyahu’s support both at home and abroad, though his popularity remains low. Both sides are playing a tough and dangerous hand. They know it.
The Market reflects a sigh of relief. The 500-point decline on the Dow overnight was erased. The price of Oil spiked, then retreated as well. WTI actually fell heading into the weekend. Still, this is a very fluid situation. The Middle East conflicts are just one of several pressure points for the Market. There’s also the nagging inflation, elevated interest rates and of course the great unknown as to who will occupy the White House in 2025.
Defense budgets are increasing around the globe. Countries continue to boost military spending to record levels. Ahead of the pack is the United States, which has allocated $825 Billion in defense expenditures for the Fiscal Year 2024. It’s expected to approach $900 Billion for the calendar year. In case you were wondering, China is second at approximately $300 Billion. Russia is third with spending that could exceed $100 Billion this year. That would be a Russian record. For perspective, the United States spends the same amount on its military budget as the next 10 countries combined. This comes as no surprise; America’s military has no peer. That’s a really big deal, especially now.
An important development has been the increase in defense spending in Europe. France has been leading the charge under Emmanuel Macron. Russia’s invasion of Ukraine certainly triggered the wakeup call. The French plan to raise military expenditures by more than one-third in the coming years. Another boost for NATO has come from founding member Norway, which just presented plans to double the size of its defense budget. In Washington, Congress is debating the best path forward for a vote on aid to Ukraine, Israel and Taiwan following last weekend’s Israeli attack by Iran. A vote could take place this week.
Parallels have been drawn between the 1970s and today for a variety of issues. Both experienced a period of multi-decade high inflation. A Middle East war also links the decades. War fatigue plagued our nation. It was Vietnam in the 70s and the end of the military engagements in Iraq and Afghanistan in the 2020s. None are considered American victories.
Some of you remember the Arab Oil embargo. It was not a pleasant experience. The State Department described it like this: “During the 1973 Arab-Israeli War, Arab members of the Organization of Petroleum Exporting Countries (OPEC) imposed an embargo against the United States in retaliation for the US decision to re-supply the Israeli military and to gain leverage in the post-war peace negotiations.” Other nations that supported Israel were also included in the embargo, which banned Oil exports to the sanctioned nations. The Iran-Iraq war at the end of the decade choked off the Oil supply as well. The limited supply sent prices soaring. American drivers were hit with a 69% increase in gas prices in early 1980. WTI hit a then-record $35, which equates to $129 today.
There was some really cool stuff in the 1970s. This will jog your memory. The Oakland A’s had a dynasty with 3 consecutive World Series titles. Boy, how things have changed… The Pittsburgh Steelers had a dynasty of their own. Disco put John Travolta on the map and the big screen with Saturday Night Fever and Grease. Jaws and Darth Vader scared the pants off of people, while thrilling them at the same time. Bell-bottoms, sideburns and mustaches were the sexy look. Well, that’s what I’ve been told. A decade that brought Charlie’s Angels and Smokey & the Bandit couldn’t be that bad.
The massive inflation played a major role in American Presidential elections in the 1970s. Gerald Ford launched a “Whip Inflation Now” or WIN campaign. It didn’t work. The inflation rate eclipsed 12%. Ford lost the 1976 election to Jimmy Carter. Inflation only got worse. The inflation rate hit a record high of 14.6% in the Spring of 1980. Jimmy Carter lost the Presidential election to Ronald Reagan in November. We all know about another consequential election this November. Inflation and overseas wars are major issues for voters to think about as they head to the polls. Americans tend to vote with their wallets. “It’s the Economy, stupid.” James Carville reminded us of that.
Similar to the Oil Embargo in the 1970s, Russia stopped the flow of Oil and Natural Gas to Europe in 2022. The price of WTI surged over $120 a barrel. It stands at $83 today. A big difference is the United States does not depend on Middle East Oil anymore. Another important factor: America’s Economy is much more energy efficient. The US Economy uses about a third of the energy per inflation-adjusted Dollar of economic activity that it did in 1970. It’s about 44% of what it used when inflation peaked in 1980.
The 1970s Oil shocks significantly reduced the use of Oil as a primary source of fuel for electricity generation. It is less than 1% today. Natural Gas is the largest fuel for electricity generation in America at just under 40%. And more importantly, cars today are much more fuel-efficient. Despite significantly more miles driven, there’s much less fuel consumed per consumer. Electric vehicles are certainly playing a role here too. That means Americans are spending far less on Oil compared to other items. The United States learned a lesson from the embargo and took steps toward becoming energy independent.
Oil and Gas prices have increased significantly this year. But it’s also important to remember that the price of Oil actually went below zero during Covid as the lockdown put driving to a near standstill. The price of Oil is nowhere near all-time highs. It’s nowhere near the highs from the Russian invasion of Ukraine. As an aside, I had no idea that the price of Oil could go negative… It certainly did in 2020. Covid. Those were some weird, unprecedented times.
Another similarity between the 1970s and today: Rate hikes. Then Fed Chair Paul Volcker hiked the overnight rate to nearly 20% to finally break the back of inflation. It worked. But a lot of damage was done. Current Fed Chair Jerome Powell launched a rate hike campaign of his own, rivaling only the Volcker move. Powell has taken the Fed Funds rate from near zero to the current range of 5.25%-5.5%. It has stood there for months. The Market had been pricing in rate cuts in 2024. Those cuts have not come.
The Fed Chair made it clear that rate cuts are not near. Recent inflation data has introduced uncertainty over when and whether the Fed will even be able to cut this year. The Market was pricing in 6-7 cuts at the beginning of the year. There’s a real chance that there are zero cuts in 2024. The Market is now assigning just a 16% probability of a cut in June. Back in February, it was close to 100% certainty. Things have changed drastically. The price of Oil and other commodities has spiked of late. Expanding wars are a big driver. That fuels the price of other stuff. Prices around the globe have reversed and headed higher. The last mile to the Fed’s 2% goal has proved beyond challenging.
This from the Fed Chair: “Last year, rebounding supply supported US growth in spending and also employment, alongside a considerable decline in inflation. The more recent data show solid growth and continued strength in the labor market, but also a lack of further progress so far this year on returning to our 2% inflation goal.” Bottom line: America’s economic strength and resiliency have surprised with staying power. Prices remain high with strong demand. Until that dynamic shows substantial signs of change, higher rates are going to stay.
So that means higher for longer. For now, the next move on rates is expected to be a cut. There’s no guarantee though. Things could get really rocky if that stance ends up shifting to a hike, which could happen if price pressures put the so-called “soft landing” in doubt. The Market has certainly been responding to that.
The yield on the benchmark 10-year US Treasury note just reached its highest level since November. It touched 4.68% this week. It started the year at 3.86%. It’s climbed nearly a full percentage point in 2024. The Dollar has been rising too. The 10-Year and the Dollar have traded in lockstep since last Summer. Their rises have proven bad for stocks.
Back to the Market:
5 months without a 2% decline; That’s over. 13 months without a 3% intraday reversal; That’s over. One of the longest stretches for the S&P above its 50-day moving average; That’s over too. After 5 consecutive months of a risk-on rally, the Market has switched decisively to risk-off in April.
Keep in mind, the Stock Market exploded higher to start 2024. It was up 10% in Q1 hitting fresh, all-time highs. Realistically, that was an unsustainable pace. It’s now given half of it back. Looking back over the last 50 years, when the S&P was up 10% in a quarter, the smallest correction was 6%. Even though this sell-off has felt abrupt, particularly with all the global issues, it’s been pretty mild in the grand scheme. I know it probably doesn’t feel mild. But the S&P is just back to where it was in early March. Here’s the other thing: Remember, the Market does go down too…
There’s nothing like price to change sentiment. Investor psychology has switched, and fast. The Bank of America Global Fund Manager Survey recorded that investors were the most Bullish to close out March since January 2022. What do those dates have in common? They both marked all-time highs for the Stock Market. That was then. April brought serious price action change. Bulls turned to Bears quickly. Bullish sentiment has now fallen to the lowest level since November. That was near the bottom. It’s not surprising given recent price action.
Buy low and sell high has been the proven path for investor success for centuries. But human emotion has often led to the opposite. Investors have proven time and again that they get overly optimistic, and at times exuberant, at highs and panic at lows. Corrections are designed to address just that; burn off the excesses and create some fear, which results in a buying opportunity. The AI craze is simply the most recent example of euphoric hype. Tech has been hit hard of late. They always get ahead of themselves, even when the secular growth trend is sustainable, as we believe Artificial Intelligence is. Being an investor takes both patience and guts. It’s never a smooth, straight line.
The Market is pretty oversold at this stage. We could see a reversal rally in the coming days/weeks. But one thing is clear, the road ahead in 2024 remains quite bumpy. Keep those belts buckled.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
