One of the things that makes trading in the market so exciting — and frustrating — is the interplay of different issues, fundamentals, trends and surprise events that affects stock prices.

It is one of the reasons we have to be careful about making inflexible plans based on the information we have available to us now. Circumstances can change so quickly.

Market events like Federal Reserve announcements, labor reports and earnings data are the easiest factors for us to understand. We have a lot of historical data from prior events that look similar.

Using historical data, we can make general estimates about the impact any of the previously mentioned events will have on the market. And we usually get pretty close on average.

Market Externalities

However, there is a subset of market events that exist in their own category. We usually refer to these issues as “externalities” because they do not arise from the normal ebb and flow of the business cycle. They are imposed on the market from outside.

Classic examples of externalities are hurricanes, earthquakes or blizzards, which can have a temporary impact on the market. We addressed these issues in a September update during hurricane season.

“Geopolitical risks” are another category of externality. And while a geopolitical risk isn’t a natural phenomenon, it is outside of the business cycle.

This category includes things like sovereign debt defaults, Brexit or the threat of armed conflict. The current escalation of attacks and reprisals between the U.S. and Iran — most recently with the assassination of Iranian General Qassem Soleimani and Iran’s retaliatory missile strike — falls into this category.

There are a few things we can anticipate right off the bat. Trouble in oil producing nations usually drives the price of oil higher. As you can see in the following chart, the bullish trend of oil accelerated following the news from Iraq and Iran.

Yesterday’s decline isn’t an “all clear” signal. We should keep our eye on the selling to see if it continues. More selling may indicate an opportunity for bigger profits in our portfolio.

Analyzing Patterns

The price of oil jumped 40% during the first few months of the 2010 “Arab Spring” uprisings, but the gains were also short lived. This situation could present a similar opportunity.

Besides the tragic loss of lives during armed conflicts, the uncertainty spawned by these geopolitical risks can also dampen market prices. However, the magnitude of the effect a geopolitical risk has on the market is nearly impossible to predict. We do not have a long-term track record of similar enough events to draw conclusions.

Although our data are limited, we think it’s still productive to look for similar patterns that emerge during events like this. It would at least give us some perspective. Perhaps we can even create some benchmarks to monitor for a warning that things may be getting worse from a market perspective.

Safe Havens

Classically, the U.S. dollar, gold, the Swiss franc and the Japanese yen act as safe-haven “stores of value.” In that respect, the gains in safe havens like gold and the franc — and the yen to a lesser extent — over the last week reveal some stress in the market.

As you can see in the following chart, the rally in gold and the Swiss franc preceded the assassination of Soleimani and Iran’s retaliatory attacks. The trend has accelerated since that time.

The last time safe havens moved in a coordinated way like this after a “geopolitical risk event” was the bombing of a Saudi Arabian Aramco pipeline in Abqaiq on Sept. 14, 2019. The risk of an escalation at the time boosted safe havens and oil, but the effect was short lived as you can see in the chart above.

Aftermath and Opportunity

Because the duration and magnitude of events like this can be so varied and difficult to predict, we think it is more useful to consider the reaction the market has when the risk starts to fade. Unless the underlying economic fundamentals are affected, rebounds following crises like this tend to be robust.

A classic example of this was the Russian invasion of Crimea in February and March of 2014. At the time, investors had trouble pricing in the risk that NATO, and therefore the U.S., would become involved in an armed conflict with Russia.

Although the issue wasn’t resolved, the market found an equilibrium of sorts in the summer of 2014. Prices on the S&P 500 rallied 9%.

It may sound odd to compare the escalation of conflict in Crimea with the current issues between the U.S. and Iran. But it is the nature of risks in this category to be unique.

What wouldn’t be unusual is a rally in the aftermath of the conflict with Iran. Assuming further problems can be averted, there could be great opportunities to profit in the short term.

A similar post-crisis pattern emerged after the North Korean tensions of August 2017 when the market gained 18%. After the Eurozone debt crisis in October 2011, the market gained 27%.

Therefore, our focus is to make sure we have conditional plans ready to take advantage of any opportunities that arise.

The Bottom Line

The U.S. labor report will be released this week on Friday. We expect the numbers will be lower than last month’s blowout but still better than expectations. If correct, we think prices in the retail sector will rally in the short term.

The earnings season for the fourth quarter of 2019 is about to start next week. Banks will begin their announcements on Wednesday. Although we are optimistic about the numbers, we think declining growth rates will keep investors focused on value stocks over small-capitalization names and riskier issues.

John Jagerson & Wade Hansen are just two guys with a passion for helping investors gain confidence — and make bigger profits with options. In just 15 months, John & Wade achieved an amazing feat: 100 straight winners — making money on every single trade. If that sounds like a good strategy, go here to find out how they did it. John & Wade do not own the aforementioned securities.