How Should Investors Handle Iraq?

By: Chris Ciovacco | Thu, Jun 12, 2014
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Stunning Advance Brings New Risk For Investors

Iraq Crisis Plan

If top policy makers and military leaders were caught off guard by the military action in Iraq, as reported by The Wall Street Journal, then we can assume the same can be said for many investors. From Reuters:

The stunning advance of the Islamic State of Iraq and the Levant, which aims to build a Caliphate ruled on medieval Sunni Islamic principles across Syria and Iraq, is the biggest threat to Iraq since U.S. troops withdrew in 2011. Hundreds of thousands of people have fled their homes in fear as the militants seized the main cities of the Tigris valley north of Baghdad in a matter of days. The security forces of Iraq's autonomous Kurdish north, known as the peshmerga, or those who confront death, took over bases in Kirkuk vacated by the army, a spokesman said. "The whole of Kirkuk has fallen into the hands of peshmerga," said peshmerga spokesman Jabbar Yawar. "No Iraqi army remains in Kirkuk now."


Fear Can Be Tamed With Contingency Planning

Events that catch investors by surprise often induce fear and tossing and turning at night. Making investment decisions based primarily on fear is a recipe for stress, frustration, and disappointing performance in the markets. A recent example was the scary 1929 parallel chart that was making the rounds on Wall Street in the first quarter. Rather than liquidating stocks based on the depressing 1929 head-and-shoulders analogy, we penned the following on February 11 as an alternative and more rational approach to portfolio risk management:

If we know the neckline has to break before the 1929 analogy can play out, then we also know as long as the S&P 500 stays above 1,746 and 1,737, then the odds of a 1929-like crash are somewhat limited. Therefore, one way to handle the 1929 scenario in 2014 is to:

  1. Not lose too much sleep as long as the S&P 500 stays above the neckline (1,746 and 1,737 are good reference points).

  2. If the neckline is violated, begin to reduce risk in a pre-determined manner using an IF, THEN strategy.


Did The 1929 Plan Help Reduce Stress?

The before and after charts say the simple and hypothetical "don't lose too much sleep" strategy was useful from a psychological and investment perspective.

$SPX S&P 500 Large Cap Index INDX - Relating now to 1929


Back Of The Napkin Plan For Iraq

Our purpose here is to illustrate the concept of using guideposts to manage stress and portfolio risk. A simple and hypothetical approach to the legitimate concerns being raised about the unrest in Iraq is to use areas of possible support on the S&P 500. For example, we might think along these lines:

$SPX S&P 500 Large Cap Index INDX

  1. If the S&P 500 stays above 1,902, don't lose too much sleep over Iraq.

  2. If the S&P 500 closes below 1,902, consider making adjustments to step three below.

  3. If the S&P 500 closes below 1,880: (a) cut stock exposure by 10%, and (b) choose the next prudent line in the sand to manage risk using an IF, THEN strategy as outlined on October 18.


People Are Looking For An Excuse To Sell

The negative impact from Iraq was complimented by weak reports on U.S. employment and retail sales. From Bloomberg:

"People are looking for a reason to sell stock right now," Dan McMahon, director of institutional equity trading at Raymond James and Associates, said in a phone interview. "The economic numbers were a little disappointing. You can't make new highs everyday." Investors are watching developments in Iraq, where Islamic militants extended gains after capturing the country's second-biggest city, while the U.S. weighed an Iraqi request for air support. Oil climbed to an eight-month high on concern the fighting will hurt exports from the second-largest producer in OPEC."


Investment Implications - Prudent Decision Making

Since the market's pricing mechanism determines the value of our investments, it is the market's reaction to Iraq, rather than our personal views or fears, that is most relevant. If the situation in Iraq continues to escalate in a troubling manner for stocks, it is unlikely that the S&P 500 will hold above the 1,902 line in the sand. Conversely, if the S&P 500 remains above 1,902, then logic tells us the market is not overly concerned about the situation in Iraq. The line in the sand gives us a firm guidepost to assist in our decision making process.

We hypothesized Wednesday that it would take a cluster of weak days to cause significant damage to the market's tolerance for risk. As expected, Wednesday's session had little impact on the readings of our market model. Since the model serves as our guidepost for decision making, we have made no allocation changes this week. We continue to hold stocks (VTI), leading sectors (XLK), and Treasuries (TLT). If the incoming economic data and unrest in Iraq result in further weakness in equities, we will not hesitate to make the necessary defensive adjustments to our portfolios. For now, we remain in "monitoring the situation" mode. If you prefer to build your IF, THEN plan using the Dow as a guidepost, the chart below may be helpful.

$INDU Dow Jones Industrial Average INDX

 


 

Chris Ciovacco

Author: Chris Ciovacco

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. CCM helps individual investors and businesses, large & small; achieve improved investment results via research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions.

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