Syria Impacts the Markets How?


Late Monday, August 26, U.S. Secretary of State John Kerry alerted Syria that it would be held accountable for using chemical weapons. Subsequent price action for the S&P 500® Index (SPX) (Figure 1) has reversed the market’s attempt to restore July’s bullish momentum. Apparent “safe havens” such as U.S. Treasuries (Figure 2) and the Japanese yen (Figure 3) are pricing counter to their 2013 trends with modest appreciation. 

By no means would I consider myself a political analyst, nor should any of you. The reality of this unfortunate situation is that very few have a clear understanding of the path that will be followed. What is known is that geopolitical tensions, the ultimate enemy for risk assets, are now present.

I expect this will place the SPX in a vulnerable near-term position that investors should not ignore. The 100-day moving average rests below the market at 1636.78 and will be used as a critical point of reference for algorithmic trading models to reduce exposure.  A sustained sell-off below 1636.78 positions the SPX for a deeper decline below 1600. As a point of reference, the 200-day moving average rests at 1557.06.

Prior to the Syrian development, I had expected overweight exposure to risk assets should be maintained heading into September, as an uptick in U.S. growth would likely continue to unfold and the FOMC would acknowledge that with the initiation of its asset purchase tapering. Syria’s geopolitical tensions should not impede expectations for U.S. growth; however, given the uncertainty of the situation and the accompanying increased volatility that is expected, reducing exposure on a tactical basis is presently warranted.

Those currently maintaining overweight exposure to risk assets should consider modest reallocations toward the safety of select corporate balance sheets via the taxable fixed income markets (Figure 4). Those balance sheets will prove relatively immune to the expected increase in Syrian-related volatility over the long run.

Over the past few months, I have suggested exposure to the energy sector should be increased. The Syrian tensions do not alter that view. The overall energy sector (Figure 5) should continue to have the ability to outperform its SPX peers. The sector has been re-rating higher in the past few months despite the significant weakness from mega-cap companies Exxon Mobil (XOM) and Chevron (CVX) (Figure 6). Geopolitical tensions in the Persian Gulf will increase pricing power and accelerate the re-rating higher. However, investors should resist the urge to position portfolios based on a spike in the spot price of oil (Figure 7).  Exposure to energy should be allocated in a highly diversified capacity.

Yesterday I put out a brief commentary highlighting the cyclical challenges that are in place for the emerging markets for the remainder of 2013. Syria’s geopolitical tensions are a near-term headwind for the emerging markets. However, investors should view the weakness of the currency, in particular, as a necessary evil for future growth. Growth will reaccelerate for those emerging market economies that do not carry large current account deficits in the second half of 2014. South Korea (Figure 8), whose economy is largely tied to the U.S. and carries a current account surplus, would be one such example.

For the third quarter of 2013, the price of gold has appreciated 15%, and the price of silver has appreciated 24% (Figure 9). That appreciation has shaved the year-to-date decline for gold to -16%, and for silver to -20%. The geopolitical tensions surrounding Syria will place a supportive price floor for both gold and silver. However, near-term challenges facing emerging market central banks and expectations for U.S. growth and FOMC tapering at its September meeting suggest that investors should resist the urge to increase precious metal portfolio holdings at this time.

Overall, this is not a call to raise cash or offer any sort of apocalyptic view. Rather, this is a prudent acknowledgement that a variable has been introduced into the capital markets whose outcome is unknown to most, if not all. Therefore, to maintain significant overweight risk exposure does not incorporate proper portfolio risk management. Hopefully, the Syrian storm clouds lift quickly, and investors can once again focus on the improving fundamentals for the economies of the United States and eurozone.

Figure 1 S&P 500 Index (SPX), Year to Date8.27 Terranova 1.1
Source: Bloomberg

Figure 2 U.S. 10-Year Treasury, Year to Date
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Source: Bloomberg

Figure 3 Japanese Yen, Year to Date
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Source: Bloomberg

Figure 4 Moody’s Corporate Bond BAA Average Yield, Year to Date
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Source: Bloomberg

Figure 5 SPDR-Energy Select (XLE), Year to Date
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Source: Bloomberg

Figure 6 XOM and CVX, Year to Date
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Source: Bloomberg

Figure 7 Spot Price for Brent Crude Oil, Year to Date
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Source: Bloomberg

Figure 8 South Korea Won, Year to Date
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Source: Bloomberg

Figure 9 Gold and Silver, Year to Date
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Source: Bloomberg

Past performance is not a guarantee of future results.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.