Stocks were on pace to push to new highs this week, but the worsening situation in Iraq seemed to put a damper on the recent rally. Still, the indexes did recoup some of the losses on the week as the S&P 500 and Nasdaq gained 0.30 percent on the day, while the Dow Jones Industrial Average was up 0.20 percent. Oil prices have jumped, with West Texas Intermediate Crude Oil climbing above $106 a barrel, helping energy stocks buck the market’s losses over the week.
The deterioration of conditions in Iraq has drawn a lot of media attention, but thus far the financial markets have only started to price in the risk. Stocks enjoyed a strong rally last week and sentiment indicators were extremely bullish this week. Were there no news at all, the mild dip in prices would be an ordinary daily move.
Still, the situation in Iraq is a concern. Sunni fighters from an Al-Qaeda offshoot are active in both Syria and Iraq and they seek to build a new Islamic state. Iran does not want to see a jihadist Sunni state emerge in the region and has sent forces into Iraq to push back the insurgents.
When Russian stocks dipped it was a good buying opportunity because Russia and the United States were not going to escalate the confrontation. In Iraq, one of the sides consists of Al-Qaeda trained fighters and another is Iranian Revolutionary Guard fighters. Escalation may not occur, but the risk is higher.
Even though the situation in Iraq caused a spike in oil prices, the long-term trend remains positive. Although tensions in Ukraine generated a price spike in February, and tension in Iraq generated another one this week, the general trend is unchanged. A stronger U.S. economy is one reason why oil prices continue to perform well, and though concerns over China persist, the economy there is still growing at a reasonable pace. The European Central Bank’s policy decision last week adds liquidity to global markets, which will be used to chase hard assets such as oil.
Investors tend to overreact to geopolitical events, both to the degree they attribute market broad movements and to the degree to which they adjust asset prices. In a narrow market such as oil, we can definitively say the news in Iraq moved prices higher, but for the stock market it is really impossible to say. Even in the oil market though, the long-term trend will dominate and the situation in Iraq may be seen as minor event as tensions ease. Investors should not become overly concerned with the new of the day and remain focused on a long-term strategy. Take advantage of volatility if it presents itself, but otherwise do not be concerned about geopolitically driven volatility that may overstated by the media.