Last weekend, Iran launched hundreds of drones and missiles against Israel. This direct military strike from Iran against Israel is unprecedented. Israel will respond, but how and when are unknowns.
To date, market action is remarkably sanguine, given the heightened military and economic risks flowing from the attack. U.S. equities have traded modestly lower, not because of the attempted assault on Israel but because U.S. equity markets were overbought. The equity markets were due a correction and some consolidation; that is what is happening. What is surprising, however, is those “knowns” which create real measurable risk and, in turn, how some asset classes are not behaving as common sense would suggest.
As a hedge against the outcome of Israel’s response, the market should logically buy large oil companies with very strong balance sheets and diversified asset portfolios. But stocks like Exxon Mobil and Chevron have traded down over the past few days. The stocks should be outperforming the market, they are not. The market is mispricing risk.
Similarly, in times of crisis, U.S. Treasuries typically rally strongly. When the prices for Treasuries rise, yields fall. Prices and yields move inversely. But the yield on the benchmark 10 year Treasury has gone up since the Iranian attack on Israel. That is surprising. Where market action is logical is the market for U.S. dollars, the preeminent safe haven asset. The market is efficiently pricing the U.S. dollar.
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Most bizarrely, is the price action in global oil markets. Oil prices are stable. Logically, oil prices should be much higher. The world economy runs on oil. Iran exports about 1.5 million barrels a day, that is approximately 1.5% of global demand. Equally important, Iran has proved in the past that it and its proxies have the ability to mine and partially close the Straits of Hormuz, an important choke point for up to 20% of the global oil supply.
Make no mistake, Israel will respond. Equity markets and the market for U.S. Treasuries are not priced for what appears to be inevitable, an escalation of military action in the Middle East.
James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note.