Buy the Rumor, Buy the (Sort of) News

Here’s the good thing about an agreement to sign a memorandum of understanding later in the week (on a day when US markets are closed) – you can buy the rumor AND buy the news. 

It is indeed an unequivocal positive to learn that there is a path to ending the war in the Persian Gulf.  We want to see no missiles flying around the region and oil prices normalize.  Those would be beneficial for people all over the world, let alone global economies and markets.  But it is a unique feature of current investor psychology that we can buy stocks when rumors of positive news arise, then buy them again when they seem credible, then buy them again – even more aggressively – when the positive news arrives.

Let’s also not lose sight of the fact that the current deal is not a permanent end to the conflict.  Should it be signed on Friday as expected, it is said to include the following:

• An immediate end to all military operations
• This is a memorandum of understanding to end the war, not a treaty
• An agreement by both the US and Iran to reopen the Strait of Hormuz once the memorandum is signed
• Iran agrees to neither produce nor acquire nuclear weapons
• No urgency to extract Iran’s enriched nuclear material, nor specifics on inspections
• No new US or UN sanctions on Iran until a final deal is reached.  US oil sanctions would be waived for a period, then all sanctions would be lifted on a timetable
• Iran says the US will unfreeze $25 billion in frozen assets, though the US says Iran would not be provided with cash

There is no doubt that the world is better off than it was a week ago, though I’ll leave it to readers to determine the degree to which this improves upon or returns us to the pre-war state of affairs.

Oil markets are certainly encouraged, as well they should be.  August Brent (COIL) and July WTI (CL) futures are both trading about 5% lower this morning, reflecting a greater degree of certainty that the global supply of oil is likely to normalize.  Note, however, that futures markets expect no return to the pre-war pricing regime anytime soon.

Term Structure of WTI Futures, Today (white), Friday (blue), 6-Months Ago (red), as of February 27 (purple), with Vertical Line Denoting January 2027; Differences Vs. Today (bottom)

Source: Bloomberg, past performance is not indicative of future returns.

Term Structure of Brent Futures, Today (white), Friday (blue), 6-Months Ago (red), as of February 27 (purple), with Vertical Line Denoting January 2027; Differences Vs. Today (bottom)

Source: Bloomberg, past performance is not indicative of future returns.

As the charts above show, commodities markets imply that it will take years for oil prices to return to the levels that prevailed prior to the hostilities.  Looking out to January, as delineated by the white vertical lines, we see futures pricing more than $10 above the immediate pre-war level and nearly $20 above the levels of last December.  Interestingly, oil was seemingly in a glut then, with futures in contango rather than backwardation.  Considering the backlog of ships that need to traverse the Strait and the need for major economies to rebuild depleted inventories, the supply-demand balance for crude oil is now deemed to have shifted for several years.

Perceptions about rate hikes have also improved in recent days.  Last week, Fed Funds futures were fully pricing in a rate hike for December, with an additional 13% chance for a second.  This morning, that slipped to a 77% chance for a December hike, with a full hike now priced in for March.  This certainly makes Wednesday’s first press conference for new Fed Chair Warsh a bit less tense. 

Stock traders, meanwhile, are not waiting around for any of these important factors to fully resolve.  It’s been onward and upward all morning.  Buy the rumor, buy the news, chase it higher.  If we had a downtick this morning, it’s been fleeting.  Energy stocks are the worst performers on the day, as one would expect, and industrial stocks have been solid performers, with the former sector down 3% and the latter up 2%, respectively.  An improving cost scenario for consumers of raw materials and the possibility for economic expansion are indeed a boon for those stocks.  But industrials are pikers compared to tech stocks, with those up well over 3%.  There might be no tangible reason for those stocks to rally so sharply, but that’s where traders gravitate when good news leads to a risk-on mentality.  Who are we to question that?

That provides the best explanation for a morning like this.  We had our little flirtation with lower prices last week, now let’s put that behind us, shall we?   It’s about animal spirits, not a sober look at fundamentals.  Yes, we’re still riding high on the positive earnings and guidance that emerged during the last earnings season, but if the rally was strictly about that improvement, we’d have to ask ourselves how long we can keep riding a factor that should have been fully discounted weeks ago.  Sometimes it’s less about a reason than a rationale.