Think Twice Before Trading on Iraq

 | Jun 12, 2014 | 3:45 PM EDT
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The market despises uncertainty, and suddenly we have uncertainty in spades from a place we were trying to forget, Iraq, which increasingly is looking like some sort of failed state.

Right now, our government is pondering action, some sort of action, and we don't know what it is. Worse, judging by President Obama's conference today, he doesn't seem to know what to do, something quite evident from his insistence on not ruling out anything.

Plus, he's saying "short-term, immediate things" need to be done militarily to preserve the situation, which, judging by the immediate decline in the stock market after he spoke, means that something could happen as early as this weekend.

So what will it be? Airstrikes? Drones? Soldiers? Boots back on the ground in Iraq? More lives lost in defense of a government that many Americans hate because the good works of our soldiers already seem undone?

That's uncertainty writ large. We've had many overseas issues in the last few years that have caused hiccups in the market: Egypt's Arab Spring, North Korean saber rattling, Cyprus' implosion, Syrian insurrection and, of course, the Ukraine. But none of these rose to the level of U.S. military action.

Plus, we are no stranger to declines caused by Iraq. While we have gotten used to Washington causing declines in the stock market, we must always remember that we had not one but two bear markets brought on by Iraq: Saddam's invasion of Kuwait in 1990 and our 2003 invasion of Iraq itself. Both caused tremendous dislocations for a variety of reasons.

Now, no one is talking about another full-blown war over Iraq, although we know that when the president uses language like "it is clearly an emergency situation," nothing can be dismissed.

And the first issue to think about, always, is the potential loss of life of our men and women in the armed forces.

The market understands that and has never been able to price in direct military action but always furiously tries to do so ahead of that action. That's why the lion's share of the declines in both Iraq wars occurred before the shots were fired, which is where we are right now, hence the need to be cautious.

Of course it doesn't help that we were at the lowest point for the fear index in ages ahead of this crisis. Nor does it help that Washington itself is in turmoil, as many political leaders from the opposition feel the need to lambaste the president, including House Speaker John Boehner, who accused the president of taking a nap on Iraq.

The markers do not like it when our president looks weak and seems to lack authority, and comments like Boehner's don't lead the people to believe that Obama is acting from strength. It's more like he's acting with some degree of confusion, which does seem understandable, given the speed with which major parts of Iraq have fallen into the hands of anti-U.S. insurgents.

A market sent down by a president who is perceived to be caught off-guard is not a market you want to rush headlong into. It doesn't inspire buying, especially when you know that we are a little more than a percent off all-time highs. If anything, we have to say, let's give this one some room, let's see how it plays out, particularly because something unexpected could be very imminent.

Now, Iraq has more than just military implications for the market. Iraq is currently producing 3.6 million barrels of oil a day. The world is thirsty for oil. We don't know if the Saudis, the logical swing factor in the oil market, can make up for a real shortfall in oil, and it appears that, already, 500,000 barrels of oil production could be imminently at risk.

Now we keep hearing that the insurrection is occurring far away from the big-producing oil fields. But if there is a full-blown civil war, it's perfectly logical to believe that the workers in the oil fields will not show up and that the pumping will decline sharply.

I think, conservatively -- conservatively now -- the price of oil could easily increase by 10%, something that Dan Dicker, the energy expert at TheStreet, concurs with. When you get that kind of increase from the already inflated base of $106 for West Texas crude and $112 for the more important Brent that our gasoline is priced off of, then you can see the financial damage that an oil stoppage in Iraq could provoke.

A previous spike in oil from the 1990 Kuwait incursion helped trigger the bear market of that year, and the sudden spike in oil to $145 in 2008 helped precipitate the Great Recession. Oil is just a gigantic tax on the American people, and while there are 10 states whose economies get some boost from an increase in oil, the rest of the country just plain gets stung by it.

Now typically, I decry those who use foreign dilemmas to explain why they are selling. You have heard me say endlessly that most of these overseas crises are just buying opportunities. But given the immense complexity of the Middle East with the Syrian civil war, Iranian provocation and a government in Iraq that may lose control of the situation with alacrity, we have to presume the worst about oil for the moment.

And that makes more for sideline watching than plunging in to take advantage of the first break in a market that's near the all-time highs. Put simply, it's a new situation that just began to be baked in, and that means caution is needed.

Why not be more aggressive? Simple, because it is about the numbers. It is always about the numbers. And unlike the other foreign crises enumerated earlier, this one has a clear impact on the numbers. In fact, if oil increases much beyond where it already has, I think you will see a wave of number-cutting, and it will be in leadership areas in the market.

Take the classic example of the airlines. I have liked these now for a year and a half. I still do because of the consolidation that has caused less competition and higher prices. The airlines have been minting money, and the estimates have risen continually. That's how you get such huge gains, and the gains in the airlines these last two years are breathtaking. Delta Air Lines (DAL) has quadrupled in two years. Southwest Airlines (LUV) has tripled. The astonishing rise in the merged and reconstituted American Airlines (AAL) is the stuff that dreams are made of. How fitting that they could be derailed or at least stunted by this tempest.

Normally I would say, "Use this nearly 7% decline in American to buy. Take down some Delta here, off 6%." But I can't. I can't because any one of the multiple analysts who like these stocks could slash numbers and downgrade ratings tomorrow.

Same thing with travel, leisure and retail stocks. Gasoline was high enough at the pump going into this crisis that we had to worry about all three. Now we have to ponder $5-a-gallon gasoline, and that too is going to cause numbers to be slashed.

Believe me, the potential for increased estimates for the roughly 10% percent of the market that does better with higher oil prices will not make up for across-the-board estimate cuts.

So what to do? Pretty simple. If you have cash, do what we did for my charitable trust today, which you can follow along at Action Alerts PLUS: Nothing. That's right. We are waiting. There is now no hurry. Let's see how things play out. If you have some outsized profits in stocks, remember that we aren't even 2% from the highs. Feel free to take them. I've been through two Iraq shocks already. I know these aren't investible until after the cannons start firing, not before. 

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