Traders Still Avoiding Small Caps

Traders Still Avoiding Small Caps

Major Moves 

Tensions between the U.S. and Iran following the attacks on oil tankers in the Strait of Hormuz and the downing of a U.S. military drone last week has put traders on edge. Symptoms of this uncertainty have been a rise in safe-haven assets like the Swiss franc, Japanese yen, and U.S. Treasury bonds, in addition to a rise in oil prices.

President Trump has imposed further sanctions on Iran targeted specifically at the financial holdings of Iran’s supreme leader, Ayatollah Ali Khamenei, and eight other military leaders. However, because previous sanctions have been so broad, the marginal effect of further penalties seems unlikely to create enough pressure for the Iranian government to change its position on nuclear refinement. That said, additional measures may be enough to make both sides start talking more productively.

Geopolitical risks like this usually lead to an increase in oil prices as investors account for the potential of a disruption in global supply. However, investors should be very careful about assuming that the upward movement in energy prices will continue and not just drop back once a resolution has been reached.

Oil prices are also affected by the value of the dollar. If the dollar falls in value and everything else remains the same, the price of oil would rise because it requires more weaker dollars to buy a barrel of oil. The same is true in reverse when buying a barrel of oil costs fewer stronger dollars.

The effect of the dollar on oil prices can be put into perspective by comparing oil futures prices in dollars versus oil futures when priced in euros. For example, when priced in dollars, oil has risen over 12% since the close on June 12. However, when priced in euros, oil prices are up only 5%.

In my view, given that the bulk of the rally in oil prices is due to temporary weakness in the dollar and geopolitical tensions, this price spike is likely to reverse. The dollar has been incredibly strong this year, and the long-term trend seems unlikely to change. From a technical perspective, West Texas Intermediate (WTI) futures are up against the resistance level of February’s consolidation, which seems likely to hold in the short term without any fundamental changes in demand.

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