Middle east sparks ignite the volatility fire

Defensive instruments look like becoming all the rage over the coming months, and there is a real sense in the markets that investors will catch any spark which ignites the flight to safety.

The spark was created yesterday when the escalating tension from the Syrian crisis was ratcheted  up; when Secretary of State John Kerry stated that the President will hold Syria’s government to account for the use of chemical weapons due to the ‘indiscriminate slaughter’ of its own people.

The free fall these comments caused on Monday night just carried on through at the open of US markets last night, with the Dow dropping by triple digits by the close and the S&P losing 27 points – its largest fall in over three months.

The call would be for a run to safety when there is this much red on the screens, and that was noted in trading. Gold shifted $15 higher to $1415 an ounce, US treasuries jumped and the yen was bid up against all its major trading pairs. While emerging market currencies were smashed with the Indian rupee and the Turkish lira trading at record lows versus the dollar.

As you would expect when military conflict is escalating, WTI jumped; adding 2.9% (or $3.05) to  $109.01 for the October contracts – the highest level in 18 months and looks to be heading higher still.

The expectations would be for defensive stocks, and stocks which derive earnings from these underlying commodities, to follow suit and jump up as everything else follows a downward trajectory. However this was not the case, Newmont lost 3.54% and Barrick Gold followed suit losing 3.48%. Newcrest's ADR is suggesting the stock will drop 26 cents to $13.48, and does not appear to be following the gold price at all. The energy space in the US was also thumped by investors chucking out anything associated with risk, and that meant equities as a whole.

Equities globally look set for a very rough ride over the coming months - the Syrian crisis feels like the spark the markets have been searching for. There are several known knowns coming to spoil the market’s recent party, with QE taper, German elections, Australian elections and a possible emerging markets liquidity squeeze.

The aptly named ‘Indianesia’ squeeze looks like spreading to other major emerging markets such as Turkey and Brazil as their currencies drive and current account deficits grow. This will be amplified by the Fed’s first move on tapering, which will happen before Christmas, increasing the volatility for all markets and finally, Europe.

Europe has been humming along over the last four months, data has suggested it has snapped out of recession across the southern states and confidence in Germany is growing steadily. However the upcoming German elections could see Angela Merkel’s Christian Democratic Party removed from power. Her centre-right party is looking for a fourth term in office; something most political parties across the globe find difficult to achieve, and a change of government will cause instability in the eurozone as Germany is its biggest economy. Adjusting to a new political direction will cause market gyrations in the short term. Although the polls are suggesting the CDU will be returning after the September 22 election, it will still be risk for the markets.

Moving to the local market and there are three days left in the main block of earnings season. Today sees releases from Woolworths, AGL Energy, Charter Hall, Virtus Health, Transfield Service and Wotif.com. The Woolworth release will be eagerly watched and comparisons to Coles on a like-for-like basis as well as value per square metre are expected to show that Coles has once more outperformed its biggest competitor.

Opening calls are suggesting the ASX will shed 60 points this morning to drop below 5100 points and open at 5081 (-1.17%), as the Syrian crisis follows through to the local market. BHP dropped 1.54% in London overnight and its ADR is suggesting the stock will follow the global drop, losing 65 cents on the open, to drop to $34.95 (-1.82%). It will be a very rough trading session today.

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