I do not believe that Israel wants a war with Syria or Iran, the sponsors of Hezbollah and Hamas. I believe, very strongly, that Syria and Iran do not want a war with Israel. I don't think even they believe they can win such a war with the US military sitting in the middle. I think this is much simpler. Iran is negotiating.
The intent here is not to start a war, but to ensure that the US and the world know that Iran can wreak havoc through their proxies in Syria and Lebanon. It shores up their negotiating position as Iran considers the various proposals on the table for a halt to their nuclear program. Not that I expect them to actually honor whatever agreement they decide to accept, but I do expect them to negotiate the best deal they can.
The financial markets have responded to this as one would expect. The dollar moved higher, gold and oil jumped and interest rates moved lower in the so called "flight to safety" trade. And of course, stocks moved lower. But does it really mean anything? Only if the moves in the financial markets are unrelated to the events in the Middle East. If the market is really moving because the economy is slowing and market participants are anticipating a recession, then there may be something to worry about. Of course, there's an old saying on Wall Street that the market has predicted 6 of the last 3 recessions, so even if that is why the market is falling, it may not mean anything.
I don't think the risk of recession is much greater now than it was in the first quarter of this year when the market was moving up quite briskly. The only thing that has changed is the liquidity situation. Japan raised interest rates last week for the first time in six years. Last month they ended quantitive easing by hoovering $200 billion in excess reserves out of Japanese banks. That certainly has had an impact, but it seems to me that the effect was mostly to force a cutback in speculation. Time will tell whether the withdrawal of liquidity around the world was so much that it had an effect on the real economy. I don't think so.
US corporations are still flush with cash and earnings are coming in with likely double digit gains again this quarter. Some companies are starting to reduce estimates of future earnings, but it doesn't seem drastic. The Fed raised rates at their last meeting, but my guess is that it will be the last, at least for a while. With housing slowing and the economy slowing from the blistering pace in the first quarter, the Fed will want to be careful to not overshoot and knock us into recession. We may find out more about their thinking when Bernanke testifies to Congress this week. We'll also get the minutes of the last meeting which could prove interesting. We'll also get inflation figures this week, but if I know those are lagging indicators, surely the Fed does too.
I continue to believe that there is excellent upside potential to this market. It'll take a catalyst, but maybe this latest skirmish in the Middle East is the beginning of exactly that. Could something good come from this? What if Iran accepts a deal on their nuclear program? What if Israel gets some assurance from Lebanon that Hezbollah will be disarmed? What if oil prices start to decline? The sentiment is so negative right now that it won't take much, in my opinion, to start a move up. If history is any guide (and sometimes I wonder), the move will be quick and waiting for it will mean missing a good portion of it.
The mess in the Middle East is not significantly different than it's been for my entire lifetime. It is certainly no reason for long term investors to sell stocks. That has usually been a poor strategy (or lack of one) in the past and I suspect it will be this time as well.