Friday’s spike in volatility, sparked by the U.S. assassination of Iran’s military chief, may be brief, as have been other market flare-ups over the past 10-plus years of the bull run and economic expansion. But with U.S. stocks priced for perfection, market professionals say the increase in Mideast tensions is a reminder of one of two things that can scuttle growth and spark a recession: a trade war and a hot war.
In light of that, experts say the U.S.-Iran tension provides an opportune time for investors to consider ways to protect their portfolios or position to buy any dips. For now, many strategists are cautioning that markets tend to overreact to geopolitics when trading is thin, as it has been during the post-holiday period. But they also warn that this news would be significant at any time of the year. Brian Nick, chief investment strategist for Nuveen, says the main implications from the U.S.-Iran confrontation will be for countries and assets tied to the Middle East and Africa—including sovereign and corporate debt and international energy companies—with limited impact to global markets, for now.
But that’s not to say there won’t be a global impact, especially as valuations had risen on the view that policy risks had decreased—a perception dashed by the latest developments. And then there is the impact on the global economy to consider. Capital Economicshas estimated that a U.S.-Iran conflict could shave a half-percentage point or more off global economic growth.
Against this backdrop, here are three ideas to bulwark portfolios with defensive moves or position for post-pullback gains:
Consider Options
To protect some portfolio profits, investors can buy bearish puts on the SPDR S&P 500 ETF Trust (ticker: SPY). With SPY at $322.41, investors can buy the March $320 put and sell the March $300 put. For $4, investors can make a maximum profit of $16 if SPY is at $300 at expiration. If the market fell 10%, the SPY trade would offset about 80% of the loss. During the past 52 weeks, SPY has ranged from $247.17 to $324.89.
The oil market, meanwhile, is surging higher haphazardly. Iran is a founding member of the Organization of the Petroleum Exporting Countries, and the first reaction investors have to anything that could trim oil production is to push prices higher. If you believe that prices will remain elevated, consider purchasing bullish calls on the United States Oil Fund LP (USO), designed to track West Texas Intermediate futures.
With USO at $13.18, investors can buy the February $13 call for 68 cents. The call is “in-the-money,” which means that it will largely track the movements in the associated fund. So, for less than a dollar, investors can potentially profit from what could be one of the most volatile trades on the planet. If the U.S. goes to war with Iran, oil prices will likely surge. At $17, the call is worth $4, representing a return of 388%. During the past 52 weeks, USO has ranged from $10.06 to $13.86.
Go Bargain Hunting
Airline stocks fell in response to the rise above $60 in U.S. benchmark crude prices that followed the Iran confrontation. Jet fuel, after all, is a big cost for air carriers. Delta Air Lines (DAL), for instance, lost 1.7%, to $58.06, in Friday trading.
The suggestion that investors may want to buy at this point is counterintuitive. Jet fuel can represent up to 25% of an airline’s total expenses. The U.S. airline industry, however, has earned record profits when oil was about $100 a barrel and seen bankruptcies when it was $40. Over the long run, it’s the supply and demand balance between airplane seats and customers that determines industry profitability.
“We expect another strong year for the airlines as top line—up 4.5%—and bottom line—up 7.2%—growth should continue,” wrote Cowen analyst Helane Becker in a Friday research report providing her 2020 airline outlook. While the report likely was written before the military strike, it is still useful as a fresh look at how carriers’ stocks should perform if geopolitical tensions diminish. Becker called Spirit Airlines (SAVE), Delta, and Alaska Air Group (ALK) her “conviction” picks for the coming year. Those are three stocks investors can dig into as the sector fluctuates, along with energy prices.
Playing Oil Volatility
Oil producers with high leverage, such as Whiting Petroleum (WLL), climbed the most Friday, because they are the most sensitive to changes in petroleum prices. Whiting jumped 8.6%, to $7.85.
Moves in the stocks of larger oil companies were more subdued. Chevron shares (CVX) closed 0.3% lower after rising earlier in the trading day. Such companies still depend on crude prices, but their business models include operations, such as refining, that can move in the opposite direction of oil. Shares of refiners, including Valero (VLO), fell more sharply Friday.
While small- and mid-cap energy names have seen outsize moves, RBC Capital Markets analyst Scott Hanold thinks investors will gravitate to larger operators that are unlikely to be as volatile, but can still benefit from higher prices. “We expect investors to continue to focus on larger-cap names and ones that have higher cash flow sensitivity to moves in crude oil, as well as no exposure to production in the Middle East, such as Continental Resources (CLR), Devon Energy (DVN), Marathon Oil (MRO), and EOG Resources (EOG).”
Write to Reshma Kapadia at reshma.kapadia@barrons.com, Al Root at allen.root@dowjones.com and Avi Salzman at avi.salzman@barrons.com
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January 04, 2020 at 05:15AM
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The U.S.-Iran Confrontation Has Raised Market Risk. Here Are 3 Ways to Position Your Portfolio. - Barron's
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