On January 3rd, shortly after the world rang in the new decade, people in the western world awoke to news that the United States had assassinated Iran's top military general Qasem Soleimani by drone airstrike. Who was Qasem Soleimani? What does this mean for peace in the region? And what does the threat of escalating conflict have on our investment outlook?
Major General Qasem Soleimani was highly influential in the region
Born on March 11, 1957, Soleimani joined Iran's Revolutionary Guard after the revolution in 1979 which saw Ayatollah Khomeini take power. Soleimani rose to prominence while commanding troops during the Iran-Iraq War (1980-1988). He was later promoted to Commander of the Quds Force in the late 90's. In 2011, Soleimani was promoted to Major General. According to many experts, Soleimani was one of the most powerful operatives in the Middle East and was highly regarded by many in Iran.
Soleimani's assassination will escalate tension, but all-out war appears unlikely
The assassination follows the significant escalation of Iranian and Iranian-backed military attacks against the U.S. and its allies—all of which stem from the breakdown of the 2015 nuclear agreement between the U.S. and Iran. President Donald Trump withdrew the U.S. from its nuclear deal with Iran in 2018. In 2019, he followed up with economic sanctions that have crippled Iranian oil exports and overall economic conditions. It's difficult to ignore that tensions have risen significantly over the past two years between the U.S. and Iran.
The recent killing of Soleimani will only escalate tensions further. It will not decrease them as some U.S. government officials are stating. In fact, Iran retaliated by firing ballistic missiles at two Iraqi military bases housing American troops. It has also been confirmed by officials in Tehran that Ukraine Airlines flight PS752 was mistakenly shot down. My thoughts are with the affected families.
It appears calmer heads will prevail as all-out war between the two nations remains unlikely. We need to remember that President Trump campaigned on winding down U.S. involvement in the Middle East.
As much as we are, markets are not conflict averse
As we've discussed in the past, financial markets do not like uncertainty. Higher levels of uncertainty typically leads to higher cost of capital assumptions, and depress equity markets if all else remains equal.
With that in mind, common sense would suggest that increased tensions and conflict would lead to more uncertainty, which in turn should lead to weaker, underperforming equity markets. Surprisingly, the data does not support this.
Analyzing returns from four wars the U.S. was involved in—World War II, the Korean War, Vietnam and the Gulf War—show that U.S. large cap stocks, as represented by the S&P 500 Index, have performed strongly during those time periods, despite heightened uncertainty.
Combining all four war periods, the S&P 500 Index rose 11.4%, which is quite strong. Relative to U.S. long term bonds (2.2% return) over the same time period, equity returns are even more impressive. War time returns even outpaced the S&P 500 Index's total average returns since 1926. Even more surprising, the data also indicates that equity volatility during the periods of war was lower than during the full period of analysis since 1926.1
We still favour equities vs. fixed income at this time
Increased tensions in the Middle East do not change our current thesis. At this time, we believe that the improving global economic outlook is not threatened.
Our overweight position in equities (relative to fixed income), is based on our assumption that global economic growth will continue to improve while central banks around the world continue to ease financial conditions (by keeping interest rates low). Even if full-out war were to become a reality, history indicates that equities should still outperform.
Our relative equity positioning, favors Western European nations—we are currently overweight in Germany, France, Netherlands and the U.K.
In currencies, we are positioned to benefit from potential oil supply disruptions because our portfolios are overweight in energy sensitive currencies like Canada and Norway.
As we hope for a quick and peaceful resolution, please do not hesitate to contact your MD Advisor* for more information about the latest news and how it can impact your portfolio.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).