There is an old trader’s saying: “It’s not the news — it’s the reaction to the news.”
The point of the saying is this: What matters more than a headline, or the substance of a news story or data point or event, is the way investors choose to interpret the information.
That interpretation depends on how investors feel, which is why emotion dominates markets.
- When investor sentiment is bullish — more driven by greed than fear — good news is celebrated and bad news is shrugged off or ignored.
- Conversely, when investor sentiment is bearish — more driven by fear than greed — bad news is seized upon as reason to be gloomy, with good news waved away as false hope.
We saw an example of this with Iran’s ballistic missile attack on U.S. targets in Iraq.
On news of Iran’s attack, S&P 500 Futures plunged in overnight markets, the Dow dropped more than 400 points, and crude oil surged 4%
The market’s justifiable fear in the moment was that, if Iran’s attack meant U.S. casualties, America would retaliate forcefully, causing Iran to attack yet again — and the hell of war would be fully unleashed.
But within a few hours, the market processed a few facts in quick succession:
- The missile attacks did not lead to U.S. casualties.
- Iran made clear it did not want the conflict to escalate further.
- Neither Iran nor the U.S. wants to turn the Middle East into a giant fireball.
And with that, the overnight plunge in the S&P and Dow reversed itself. The oil price calmed down too, and the S&P and Nasdaq hit new all-time highs in the very next trading session.
The consensus view is that, in the aftermath of General Soleimani’s death, Iran had to act in order to save face and appease anger at home. And yet, Iran left no doubt it would rather avoid a shooting war, calling its response “concluded” as long as the U.S. did not escalate.
The United States is the stronger power in terms of military might. But if a hot war starts, either side could make the battle catastrophic. Iran threatened to target Israel and Dubai if things got worse, which seemed to be their way of saying: “If this gets bad enough, everybody loses.”
The potential for disaster is good news in the eyes of the market, in part because it increases the odds of a stand-down. The threat of catastrophe becomes a feature rather than a bug in this instance, because all are incented to sidestep the catastrophic outcome.
Even still, markets didn’t have to be so upbeat.
Investors could have focused on the fact that the Iran nuclear deal is now dead as a doornail, which means Iran will be racing towards nukes (like North Korea).
They could have looked how close we came to hot war — what if American soldiers had died in the strike? — and noted that the situation is still intense, with the Middle East more of a powder keg than ever.
Or investors could simply have said “time to take some risk off the table,” metaphorically speaking, by cashing in a chunk of their stock gains, stoking a January sell-off after an exceptional run-up in 2019.
Instead, the market said “no” to pessimism, “no” to caution, and “Yes!” to more upside. Being on the sidelines is harder to stomach than another crazy headline — for now at any rate.
The S&P and Nasdaq hitting new highs in the immediate aftermath of Iran’s missile strike demonstrates the staying power of bullish investor sentiment, and the reality that investors fear missing out on further stock market gains more than they fear war. That implies more upside for stocks ahead.
TradeSmith Research Team