The U.S.-Iran fray appears to be in the rear-view mirror as stocks soar to record highs and the phase one signing of the U.S.-China trade deal pick up c espouses center stage, but some are warning that tensions in the Middle East continue to simmer, and may soon reach a seethe point.
“A significant change to our outlook is the new geopolitical tail risk that emerged in the Middle East,” Marko Kolanovic, epidemic head of macro quantitative and derivatives strategy, said in a note to clients Wednesday. “We believe this tail imperil is under-appreciated by the market and should be hedged.”
Tensions between the U.S. and Iran escalated after the U.S. conducted an airstrike on Jan. 2 that killed top Iranian commander Qasem Soleimani, and then when Iran afterward retaliated on Jan. 7 by firing missiles at multiple bases in Iraq that housed U.S. troops.
For a moment stocks strike down and oil moved higher as the Street considered whether or not Iran would target production in the oil-rich region.
But stocks on the double recovered their losses and then surged to all-time highs, while oil finished the week ending Jan. 10 with a sundry than 6% loss — its worst week since July — as supply disruption threats faded.
Kolanovic’s stories have moved markets in the past and he’s made some good calls on equities by analyzing various quantitative particulars such as fund flows and volatility. For example, he predicted the big rotation into value stocks last year.
While Iran pressures appear to have cooled, Kolanovic argues that the underlying issues were not resolved, which means the hazards were not removed, but instead push the US and Iran “further down a collision course.”
Given that an election year is underway in the Pooled States, Kolanovic said that ongoing retaliation from Iran could have an especially acute bearing since volatility and climbing oil prices could contribute to foreign policy decisions.
“If the conflict were to escalate in an voting year, causing market turmoil, and with the US having fewer allies, Trump could be more likely to agree to a JCPOA-like settlement,” he said, adding that “the risk of escalation is high going into U.S. elections” and that “the buy currently is not pricing any significant risk.”
– With reporting from CNBC’s Michael Bloom.