FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
September 3, 2013

IN THIS ISSUE:

1. 2Q GDP Rises More Than Pre-Report Forecasts

2. Understanding the Bloody Civil War in Syria

3. Obama Bluffed, Assad Called Him – Now What?

4. Majority of Americans Oppose Strike on Syria

5. Iran Threatens Attack on Israel if We Hit Syria

6. Market Implications – Oil Prices Could Skyrocket

Overview

What does the stand-off in Syria have to do with the investment markets? Potentially, a lot. As I have argued in recent weeks, if the Middle East devolves into another military quagmire, it could be quite bearish for the US stock and bond markets going forward. That’s why we will talk about the implications today.

President Obama is hell-bent on attacking Syria for gassing over 1,400 innocent citizens on August 21. Normally, it would not be unusual for an American president to want to respond to such a humanitarian outrage. But it is still not clear why this liberal president – who’s mandate was to get us out of war – is now so intent that we need to attack Syria militarily.

We begin our analysis today by briefly examining how the civil war in Syria began and why. From there, we examine whether the US has any justified reasons to get involved or to punish Syria’s president Bashar al-Assad for the recent chemical attacks on his own people. For whatever reasons, President Obama initially felt that he alone had the authority to take the US to war with Syria, and made plans to do so last week.

However, an NBC poll released last Friday revealed that almost 80% of Americans believe that the president must get congressional approval before taking the nation to war. Other polls showed that a majority of Americans don’t want the US to attack Syria, period. So on Saturday, Obama backed down and said he would wait for Congress to have its say next week.

My questions are: 1) Why was Obama in such a rush to retaliate militarily against Syria, even in the wake of overwhelming public disagreement; and 2) Why did he suddenly back down on Saturday and agree to defer to congressional approval? I hope we will get answers to these questions, but I fear that we will never know why.

But before we get to that discussion, let’s take a quick look at the latest economic reports, including last Thursday’s 2Q GDP estimate, which was revised up from 1.7% to a more healthy 2.5%, and a few other recent reports. Let’s get started.

2Q GDP Rises More Than Pre-Report Forecasts

Last Thursday, the Commerce Department reported that 2Q GDP rose by 2.5%, well above the pre-report consensus of 2.1%, and significantly higher than the advance report of 1.7% last month. Keep in mind that there will be a third 2Q GDP revision on Thursday, September 26.

The stronger-than-expected GDP number for the 2Q was primarily the result of a better trade balance – the nation exported more and imported less than previously thought. Rising exports, consumer spending and real estate spending helped boost the 2Q numbers. However, the Commerce Dept. also reported last Thursday that its final estimate of 1Q GDP was only 1.1%, down from 1.8% that was reported in late July.

Stock markets rallied initially on the better than expected 2Q GDP report on Thursday. Yet as analysts pored over the details, there was a growing sense that the report could well cause the Fed to accelerate plans to taper its bond and mortgage purchases sooner rather than later. This weighed on stocks later in the day on Thursday and again on Friday.

On August 26, the Commerce Department announced that durable goods orders plunged 7.3% in July, considerably worse than the pre-report consensus and snapped three consecutive months of gains. The next big economic report will be this Friday’s unemployment report for August. The pre-report consensus is that Friday’s unemployment rate will rise from 7.4% in July to 7.5% for August.

Understanding the Bloody Civil War in Syria

Syria has dominated the headlines in recent weeks. President Obama is threatening to attack Syria militarily for using chemical weapons on its own people on August 21, killing over 1,400 innocent citizens outside the capital of Damascus. Let’s begin by looking at how this crisis unfolded in the last few years.

The conflict in Syria grew out of the 2011 “Arab Spring” protests, when Syrians peacefully demonstrated in towns across the country against Bashar al-Assad, who succeeded his father, Hafez al-Assad, as president. Between the two, the family has held the presidency for four decades. Unlike some other countries facing democratic protests, the Syrian government responded with violence, killing many protesters and radicalizing the movement.

Civilians – aka “the Rebels” – began to take up arms over two years ago, at first to defend their demonstrations and later to fight Assad’s security forces in their cities and towns. This nascent armed movement was at first bolstered by army defectors who organized themselves under the umbrella of the “Free Syrian Army.” But in the last year, radical Islamists – including many allied with Al-Qaeda and the Muslim Brotherhood – joined the movement and some now believe they are in control of the rebels.

Today, the Assad government remains the strongest single actor in the conflict, although it has lost a significant amount of territory in the north and east and faces a stalemate against the rebels in important areas of the country, including the suburbs of Damascus and Aleppo. Despite those losses, the Assad regime possesses a strong arsenal, including a very large stockpile of chemical weapons, and has robust support from its main allies, Russia and Iran.

The rebels remain divided among hundreds of small militias and brigades, the most powerful of which are now believed to be the radical Muslin Brotherhood and Al-Qaeda groups. They control much of the country’s north and east, including its borders with Turkey and Iraq, and have reportedly begun to enforce Islamic law in some towns. The more secular rebels aligned with the Free Syrian Army are active in towns and suburbs mainly in the south, including the areas of Damascus targeted by the August 21 chemical attack.

It remains to be seen if President Obama will order a military strike on Syria. If he does, we will be aiding the Brotherhood and Al-Qaeda which have infiltrated the rebels, as noted above. The time to best help the rebels was months ago.

Obama Bluffed, Assad Called Him – Now What?

A year ago, President Obama unwittingly backed himself into a corner with his so-called “red line” warning to Syria’s president Assad. At a press conference, the president warned:

“A red line for us is we start seeing a whole bunch of chemical weapons moving around or being utilized.”

Almost one year later, on August 21, Assad’s military allegedly carried out a major chemical weapons attack in the suburbs of Damascus that killed over 1,400 innocent people, according to the State Department, including hundreds of children. Only days afterward, President Obama began calling for a military attack on selected targets in Syria.

Mr. Obama outlined a plan to attack Syria that would be “short” (maybe just a day or two), “narrow” (whatever that means) and would involve “no boots on the ground.” He also suggested in the last week of August that the attack could occur any day now, without congressional approval.

The president’s decision to attack Syria was immediately met with widespread opposition. As noted above, a new NBC poll released last Friday showed that almost 80% of respondents said that the president should get congressional approval before taking the nation to war.

Just the day before on Thursday, the White House watched with alarm as UK Prime Minister David Cameron failed to secure parliamentary support for the UK to join the US military operation. The takeaway for White House officials, aides said, was not to discount the level of war-weariness, both in the UK and at home.

Around this same time, General Martin Dempsey, the chairman of the Joint Chiefs of Staff, advised the president that the timing of a strike on Syria didn’t matter. According to officials, Gen. Dempsey’s message to Mr. Obama was that whether the strikes were launched tomorrow, or a week from now, or a month from now, the military would be able to ensure the effectiveness of the operation, officials said.

Apparently, this was a game-changer for Obama. During a 45-minute walk around the White House grounds with his Chief-of-Staff, Denis McDonough, last Friday night, Obama reportedly explained his change of heart on getting congressional approval for the strike on Syria. While that conversation was off the record, Obama apparently told McDonough that…

consulting with congressional leaders wasn't enough – all lawmakers should have to go on the record one way or the other…

At 7 p.m. Friday, Mr. Obama called his top aides, including National Security Adviser Susan Rice, back in to inform them of his plan to ask for congressional approval. Many insiders were stunned because of the risk that Congress will say “no.” If that were to happen, his aides feared that the consequences for him and for the country’s standing in the world would be enormous. Ditto for the potential market implications, as I will discuss below.

Congress is set to reconvene on September 9, next Monday, and a decision on Syria is expected to be the first order of business. The big question is whether or not a majority in Congress will approve of a military attack on Syria. And if Congress says no, will President Obama order the attack anyway? We’ll see.

Majority of Americans Oppose Strike on Syria

Americans widely oppose launching missile strikes against the Syrian government for its alleged use of chemical weapons, according to a new Washington Post-ABC News poll that finds little appetite for military action across the country despite a growing drumbeat in Washington. Nearly six in 10 oppose missile strikes in light of the U.S. government’s determination that Syria used chemical weapons against its own people.

Democrats and Republicans alike oppose strikes by double digit margins, and there is deep opposition among every political and demographic group in the survey. Political independents are among the most clearly opposed, with 66% saying they are against military action. That’s huge! The question then is, how will Congress vote?

Iran Threatens Attack on Israel if We Hit Syria

Iran is threatening to launch a massive missile strike against Israel if the United States attacks Syria, which could touch off a full-blown war in the region. “The day of reckoning is near,” according to Hossein Shariatmadari, the chief editor of Keyhan newspaper, an outlet controlled by Iran’s supreme leader, Ayatollah Ali Khamenei.

An Op-Ed penned by Shariatmadari last week warned that the impending confrontation between the US and Syria would “provide the long-awaited opportunity for revenge against Israel and America.”

Shariatmadari said that Israel is the “Achilles’ heel of America and its European allies and without a doubt with the start of an attack on Syria, thousands of missiles will rain down all over the occupied lands [Israel], which will destroy its critical facilities as it was obvious that its missile defense system [the Iron Dome] could not prevent missiles reaching Tel Aviv.”

He also warned Saudi Arabia, Jordan, Turkey and others who support attacking Syria that they themselves will come under attack from Iran.

“Muslims should welcome the news of an attack on Syria as it will provide the long-awaited opportunity for revenge, which should destroy the enemies of Islam,” he concluded.

Iran’s threats to attack Israel may be just so much hot air. If Iran did attack Israel, that would provide the opening for Israel to launch an all-out military offensive on Iran. It would provide the opportunity for Israel to finally unleash its superior weapons on Iran’s nuclear facilities.  The Obama administration has to know this.

Market Implications – Oil Prices Could Skyrocket

In my August 13 E-Letter that focused on the unrest in Egypt, I noted that some analysts had predicted crude oil prices could soar to as much as $200 per barrel if a full-scale civil war were to break out in Egypt and if the Suez Canal was somehow blocked. For now at least, the Egyptian military seems to have prevailed over the Muslim Brotherhood masses, and the Suez Canal does not appear to be in jeopardy.

But that hasn’t kept oil prices from spiking to the highest level in two years. As Egypt has moved off the front pages, the chemical attack in Syria has taken its place. The use of chemical weapons on innocent citizens in the eastern suburbs of Damascus and the deaths of over 1,400 citizens has sparked international outrage.

As tensions in Syria mounted, crude oil prices did what they always do when there’s serious unrest in the Middle East. West Texas intermediate crude prices soared above $110 per barrel last week intra-day.

A further move to $125 or higher cannot be ruled out, depending on what happens in Syria and the Middle East at large in the weeks and months ahead.

In the meantime, while Congress debates whether to give the president the authority to attack Syria, oil prices may remain in a trading range. But if the attack on Syria does go forward – with or without Congress’ approval – I will not be surprised to see crude oil soar to new highs, which is not good for the economy.

Stocks have fallen rather sharply since hitting new record highs in early August. The Dow Jones and the S&P 500 lost between 3% and 4.5% in August, but they are still up between 13% and 15% for the year. Speculation that the Federal Reserve may “taper” its monthly bond and mortgage purchases as soon as September has made investors nervous.

Should Congress approve Obama’s planned attack on Syria, or if the president decides to go it alone, this could easily cause more investors to move to the sidelines, thus putting even more downward pressure on equities. It remains to be seen if this is just a downward correction, or if the bullish trend has reversed with more to go on the downside. If the Middle East blows up, bank on the latter!

Meanwhile, US Treasury bonds ended August on a down note, posting a fourth consecutive monthly price decline in the latest sign of investor anxiety over rising interest rates. It was the longest monthly losing streak since the benchmark 10-year note posted seven consecutive monthly losses through March 2011. The yield on the 30-year Treasury bond is back above 3.8% so far today.

An expected reduction in the Federal Reserve's $85 billion monthly QE purchases continues to weigh on prices. Worries continue that the central bank may reduce its monthly bond purchases as soon as September 18 when the next FOMC meeting concludes. Analysts remain divided over whether the bond market is simply “pricing in” the Fed’s taper, or if something more is causing interest rates to rise.

If the Middle East blows up just ahead, that could well spark a “flight to safety” in US Treasuries, which could mean that prices spike higher and yields lower temporarily. If you are still overweight in bonds, that could be an opportunity to lighten-up. Longer-term, yields should move even higher, which will push bond prices lower.

Wishing you some nice fall weather,

Gary D. Halbert

SPECIAL ARTICLES

Obama’s Staggering Incompetence

When all else failed, Obama went to Congress

Rolling the dice on Syria

 

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