Amid the global chaos, something strange is happening with stocks.
…They’re up.
In Israel, for example, the stock market has soared to all-time highs. The iShares Israel ETF (EIS) is up a whopping 53% over the past year.
This is despite the fact that the country has been devastated by Iranian missile strikes. Its Haifa port has sustained unknown damage, but based on the fact that there’s a media blackout, it’s probably substantial.
Its largest oil refinery, also in Haifa, was hit hard. We have little direct evidence of how extensive the damage is, but here’s a picture with one of the refinery’s landmark cooling tower visible:
This refinery reportedly produces around 60% of Israel’s gasoline and diesel needs.
Billions of dollars of damage has been done to military sites and civilian infrastructure.
Israel has also expended vast sums of money in the war, both offensively and defending its territory with surface-to-air missiles (SAMs).
Yet the country’s stock market is at all-time highs and pushing higher. Why?
We were discussing this at the Paradigm office, and my friend Ari proposed an interesting theory. Perhaps it’s a bit like the U.S. during the COVID lockdowns.
A nation stuck at home (or bomb shelters, in this case) has little better to do than trade stocks. It’s plausible, but doesn’t fully explain the phenomenon we’re seeing around the world.
Or perhaps Israeli investors have been expecting a conflict with Iran for a while now, and pricing that in. Additionally, it is true that Israeli stocks remain cheap, with the EIS ETF only trading at an average P/E ratio of 13.
So maybe the fact that the conflict has finally occurred, and hopefully ended, is causing the widespread bullish sentiment. Markets do like it when uncertainty is eliminated.
Nevertheless, this uber-bullish movement does seem to clash with the overall state of the world…
Scaling the Wall of Worry
Here in the U.S., stocks are also in full-on bull mode. Climbing the wall of worry, as they say. And quite a wall it is… I must admit, the strength of this move has surprised me.
Considering the fact that we are in the middle of a trade war which is set to reshape the balance of global commerce, the market is performing remarkably well.
China, as we have covered extensively, has serious leverage in this situation through its near-monopoly on rare earth elements (REEs).
President Trump has made some progress on this front, but American companies are still struggling to get the rare earth magnets they need for critical industries such as autos.
As reported by the Wall Street Journal on Monday:
Ford Motor still faces difficulties obtaining vital magnets made with rare-earth elements, despite a deal the U.S. struck with China to ease export controls, a company executive said Monday.
“It’s hand to mouth—the normal supply-chain scrambling that you have to do,” said Lisa Drake, a vice president overseeing Ford’s industrial planning for batteries and electric vehicles.
…Several other carmakers say that the pace of export license approvals for rare-earth magnets hasn’t changed significantly.
Car companies have warned that they could be forced to halt factory work if they are unable to obtain enough rare-earth magnets.
It’s not just car companies, either. Semiconductor firms, defense contractors, and a big chunk of American industries could face shutdowns if the rare earth drought continues.
A rare earth shortage is just one of many potential black swans which could spoil the party. A further outbreak of war, the mounting debt crisis, another wave of inflation, and other worrisome scenarios could jolt the stock market out of its oblivion at any time.
Stay the Course
The recent strength in stocks tells me this is not a time to short the market. To confirm this, I reached out to my friend and colleague Greg Guenthner, who is one of the best market timers and traders I know, to get his take. Here are his thoughts on the matter:
Bad news (anything short of horrible) is not bad news for the stock market right now because we’re in an accelerated boom phase similar to the 1990s where high-tech themes (AI, quantum, rockets, drones, self-driving tech) are capturing investor’s imagination.
Bull markets need skeptics to continue higher. When everyone has bought in and the last bear has capitulated, then you’re close to the top.
Wise words. However, the downside risks remain substantial, particularly in sectors like technology (similar to the late 1990s). So I will continue to limit exposure to tech and the broad market, which remain overvalued.
Hard assets and select emerging markets are the place to be. Gold, silver, miners, energy, and Brazil (EWZ), specifically. All these assets remain cheap and should be resilient to potential black swans. They have the same or better upside, and far less risk.
The largest gold miner ETF (GDX) is up about 48% on the year and still cheap. So it’s not as if we’re missing out on gains. Silver miners, such as Pan American Silver (PAAS, which I own) are cheaper than their golden cousins. Meanwhile, the Brazilian market and other developing country ETFs are finally starting to catch a bid.
The dollar is weakening, and looks to have further to fall. The setup for hard assets and emerging markets looks bright.
In the near future, we’ll branch out into other natural resources such as iron and copper. Iron in particular has been in an extended bear market and miners who specialize in it have been beaten down by up to 70%. They’re worth a look for contrarians with patience.
More on that soon.
