Israel - Iran Update
Considering the recent events, I felt I should give my readers an update about the sudden explosion of war in the Middle East, which is likely to impact portfolios and geopolitical situations worldwide.
A Few Caveats
To start, I will explain what I will NOT cover.
First, I will not try to pick a side. Even if frankly, I have seen more haunting footage in the last 48 hours than in the entirety of the Ukraine War. I highly recommend my readers to NOT look for it themselves. Just trust me on this…
Let’s just agree that targeting civilians is never okay, no matter what grudge or previous atrocities have been committed by the “other side”.
Even less parading their corpses…
Indiscriminate retaliations will not be good either.
“Well the other did X too, you know, did you care about THAT” is an unacceptable rhetoric. If you think so, please unsubscribe. Works for both sides.
If I had to pick a side, it would be one of the ordinary people, as well as the Holy Land’s Christian communities (as an Orthodox Christian myself), that will likely suffer even if not a belligerent in this conflict, while also being despised by both Jewish and Muslim radicals.
There were Patriarchates of Jerusalem, Antioch, and Alexandria, way before there was a prophet Mahomet or the modern state of Israel…
What I also do NOT cover is what should be done.
This is a nasty situation getting nastier with time. There is likely no good outcome of this. I will however describe what is likely to happen and then possible scenarios moving onward.
Many people seem compelled to pick a side and flatten complex situations into simple narratives: oppressed innocent Palestinians against colonial oppression or civilized innocent Israelis against barbarians.
Calls for genocide seem also pretty okay on social media these days. From “exterminating” Israel to “flatten Gaza”, it is safe to say that rational minds are not really what dominate our collective thinking.
Quick Recap
After a sudden and surprise attack, Hamas managed to strike Israel in what can be described as a 9/11 or Pearl Harbor moment. Israel’s army has obviously been caught flat-footed and took several hours to react.
This is now responded to by mass mobilization and an official declaration of war.
The Lebanese Hezbollah is also likely to enter the conflict, opening a northern front.
Meanwhile, US aircraft carriers and military assets are likely going to provide help to Israel.
This is a stunning turn of events. And it seems at first glance that the Hamas was extremely well prepared, and have upgraded drastically its capacity, including in drone warfare, successfully replicating tactics seen in the Ukraine war.
Iran’s Role & The Muslim World
It is very likely that Iran is a key actor behind the attack. While it might not participate directly (hard to tell), it is for sure financing, training, equipping, and providing diplomatic and intelligence support to Hezbollah. Likely to Hamas as well.
This comes in the backdrop of several seismic changes in the Middle East diplomatic balance:
The acceptance of Iran into the BRICS, breaking a long-standing isolation due to US pressure.
The progress of Iran's nuclear program, which might or might not have already delivered the material needed for a nuclear weapon.
The normalization of relations with Saudia Arabia and the signing of a de facto peace treaty between the two, freeing Iran’s resources from costly proxy wars in Syria and Yemen.
The tentative of bringing back Saudia Arabia in the Western camp, in exchange for nuclear power plants and a normalization of relations with Israel. This idea is now dead in the water.
The return of Syria (an Iranian vassal state by this point) into the diplomatic arena, including the recent visit of Bashar-al-Assad to China and his very warm reception.
The greater proximity of Iran with Russia in decades, if not centuries, notably with the provision of Shahed cheap drones to Russia, as well as the template for Russia to mass produce them itself.
Russia also provided scientific and military technology to Iran and is working hard to open the North-South trade corridor.
The Armenia-Azerbaidjan War, resulting in mass displacement and murder of Armenians, a relative humiliation and loss of influence of Russia, and the displeasure of Iran.
Israel has been a key supplier of modern weapons to Azerbaijan, together with Turkey (Middle East geopolitics are never simple).
Meanwhile, the rest of the Muslim world has already condemned Israel and blamed it for the war.
China and some world powers preferred a natural stance and called for peace and a stop to hostilities.
Ukraine & US Loss Of Prestige
The war in Ukraine can be seen as a key reason for the explosion of violence, or at least its timing.
First, a lot of ammunition supplies, especially artillery shells, stockpiled by the US in Israel have been sent to Ukraine. This might significantly weaken the Israeli defense forces, especially against Hezbollah, or worse, Iran. This is very likely to have been a factor in the calculus for the timing of this attack.
To compensate, depleting the US army reserves might be needed.
Obviously, the idea of a distracted and overstretched America probably also played a large role. Exploding deficits and debt, and interest rates rising sort of out of control did not help either.
Political division, including over-providing financing to Ukraine, equally gave the image of a “window of opportunity” to be seized to settle long-standing grudges.
The successive US failures of the Iraq occupation, the debacle of the Afghanistan retreat (a rout really), the inability to topple Syria’s government, and the inability to support Ukraine enough to win, especially after the recently failed counter-offensive, have all created an image of military weakness that keeps getting worse over time.
A radical change from the omnipotent hyperpower that had “bombed back into the stone age” Serbia, Iraq, and Lybia, and taking only losses from improvised bombs and ambushes.
The overstretched supply chain for weapons, generalized de-industrialization, and mainstream media admitting there are not enough missiles, ammo, and shells in stock OR in production compounded this image.
Several reports claim Hamas acquired Western-made weapons from the Talibans, or even through corruption in Ukraine, but this is yet to be confirmed.
What’s Next?
Considering the human losses, it is politically impossible for Israel to back down, or even negotiate. This is true even with hundreds of hostages taken prisoners.
For that matter, Hamas is publicly aiming for “final victory” and is not interested in negotiation either.
This is fundamentally different from previous flare-ups in the Levant.
Both sides see it as an existential conflict for survival against an inhuman enemy to be eradicated.
"I ordered a complete siege on the Gaza Strip. There will be no electricity, no food, no fuel, everything is closed. We are fighting human animals and we act accordingly,"
Force Imbalance
The initial success of the Hamas is mostly due to surprise and preparation. But even with upgraded capabilities and improved drone warfare, it is still a fundamentally weaker force.
The same can be true to a lesser extent for the Hezbollah.
And this is true for existing Israeli military capability, not even counting the guaranteed support by Western countries, especially the US. Where the US is cautious to not be a direct participant in Ukraine, it has little reason to do so here, and there is a lot of political tendency in the US to support Israel unconditionally.
So in that context, the military outcome is rather predictable if all things stay equal.
The problem is that the only path forward for Israel is likely the partial or total destruction of Gaza, as well as its full occupation and/or deportation of its population.
(to where? is a good and unanswered question, Egypt might be forced to reluctantly accept these 2 millions refugees).
This in turn will enrage the Muslim world like nothing we have seen for these past 50 years.
I am not sure Iran can afford not to get directly involved without losing its control over its vassals in the Shia crescent.
Iran has the population and capacity to potentially crush Israel, which would force a US intervention MUCH more massive than a few aircraft carriers conducting air strikes.
Something more in line with the Korea or Vietnam Wars than the invasion of Iraq. No wonder there has been a coordinated call in the last few months for a return of the military draft and admitting the insufficiency of the all-volunteer army model.
A Way Out?
The Israeli-Palestinian conflict has been an unsolvable issue for decades, so do not expect magical solutions here.
What I can say is that ethno-religious conflicts of this kind tend to be extra nasty historically.
This is because a conflict over territory can be settled by redrawing borders (think France versus Germany).
A conflict over political ideology can be done by changing said ideology (Nazi Germany versus modern Germany as an example, or Imperial Japan).
People will not change religions easily, and cannot change their ethnicity. So there is no reasonable way out, nor possibilities to change the fundamental parameters behind ethno-religious conflicts.
Many such conflicts end with one party durably exterminating the other, totally or from a determined area. This is a pattern most common in the Middle East, the Balkans, and the Caucasus. Such actions also can create conflicts that will simmer for not decades, but centuries.
So two possible outcomes are either the permanent expulsion of non-Jews from Israel, or a complete conquest and mass explusion/genocide by Muslims powers.
Another possible outcome is an organized separation without too many human losses. Think of Croatia and Serbia. Or Pakistan and India. They might still not be friendly with each other, but overall, there has been enough mass relocation to stabilize a border between the two and luckily avoid major wars in the future.
In the Levant, who gets to keep Jerusalem makes it extra difficult. A Holy City for 3 religions, and no one is ready to give it up or accept a neutral status/free city agreement.
As long as this is true, peace will be elusive.
Financial Aftermath
Now I will actually discuss the repercussions beyond military and geopolitics, but let’s not forget the goal here is not to profit from this and ignore what really matters.
Real people will die and are dying, and I am not even going to dwell too deeply on other atrocities.
Simply, this is an investing newsletter and I would do a disservice to my readers to not tackle this topic.
So let’s look at what it might mean for the broader world.
The First Yum Kippur War
A solid template is obviously the Yum Kippur War / Ramadan War which started exactly (to the day of the attack) 50 years ago.
After an initial successful surprise attack, Israel managed to defeat the combined armies from almost the whole Arab world. This might as well be considered somewhat of a defeat for Israel, which was later forced to recognize Egypt's control over the Sinai region.
In retaliation to Western support to Israel, the OPEC would restrain supply to the West, close the Suez Canal, and overall trigger the 1970 stagflation.
Despite controlling only 56% of the world’s production, OPEC could have an outsized effect on global oil prices.
Oil Prices
Oil went from $2.75/barrel to $32/barrel in less than 10 years.
Here is how it played out:
The U.S. monthly average import price for crude oil stood at $2.75 per barrel in January 1973.
Prices drifted upward during the next four years and held around $13.50 per barrel throughout 1978.
The subsequent Iranian Revolution in 1979 would create a second energy crisis.
But this was hitting a rather prosperous and stable global economy. In fact, that period is still remembered in France as “The Glorious Thirties” (1945-1975) with the oil shocks essentially putting an end to it.
I doubt x11.6 on oil prices could be doable, or at least not without a terrible crash in dollar value. But a doubling from here, yes, not impossible at all.
It’s not like the West is also deeply in conflict with Russia and Venezuela (the other largest oil reserves on Earth).
A global recession would come with it as well.
From that perspective, if you have not hedged this risk with a double-digit exposure to the oil & gas sector yet, hurry up.
Hormuz
A black swan discussing a potential Israel/USA vs Iran/Islam conflict is the straight of Hormuz. This is from where most of the Middle East oil flows out to the world. Would the USA feel the need to collapse Iran’s economy, look no further.
This would also cause dramatic damage to Western economies, while exceptionally boosting Russia’s income.
This would be cataclysmic for Europe, whose supplies are direly reliant on Middle Eastern oil, and even Qatari LNG to keep the lights on and vehicles moving. The US would be forced to choose between supporting its allies or keeping prices at home lower, but could not do both.
So really it's a double-edged sword that cuts everyone.
Of course, Saudi Arabia’s oil is also passing by there. So we should expect such a radical move only as a desperate measure, or as a punishment to Saudi Arabia would it turn openly hostile to the West.
Oil Prediction
Besides a sudden temporary spike, I do not see oil prices exploding yet from this.
This would change if the straight of Hormuz was getting in danger, or if Iranian and even Iraqi oil facilities (oil wells, refineries, pipelines, and export terminals) would be attacked.
A more durable danger is the OPEC+ or even the whole BRICS-11 retaliating with lower oil sales to the West, extra fees or closing the Suez Canal, export tariffs on non-energy commodities, etc…
So we should watch out for a repeat of the 1973 oil shock, more than for more flashy direct damage to oil production and exports, even if those are not completely impossible.
Defense sector
I saw passing that a bunch of US senators are already buying a lot of shares in defense and oil stocks. Not surprising, is it?
Once again, this will stretch the US’s capabilities thin, with a need to maintain deterrence in the Pacific while also acting in the Middle East.
Contrary to Ukraine, Israel does not have such a deep manpower pool that the US can just send weapons. So I guess missiles and ground forces equipment manufacturers will “benefit” from the situation as well.
But let’s not lie to ourselves, making money directly from war, death, and destruction can be a little ghoulish at times.
Muslim Capital Flow
A second-order effect could be a flow of capital out of the Middle East. Israeli capital will likely find its way to NY, London, or Singapore.
A more interesting question is where the Qatari, Saudi, and UAE capital would go “for safety” if they feel their home market is not so safe anymore.
I would not be surprised to see the Chinese and Indonesian markets benefit from it. Especially if exploding oil price means a lot of capital to recycle abroad.
Inflation
Inflation is likely to reignite or stay elevated from pumped-up oil prices. And generally, military spending, combined with an intense deficit tends to increase inflation.
It will also force the global central bank to keep interests high, or even higher.
That’s very negative for bonds.
This will hurt most companies and benefit some, so invest accordingly.
Tech breaking?
Could this be the moment inflated big tech stock breaks? So far nothing has managed to pop the “everything bubble” with a high concentration in tech stocks.
Volatility is likely going to be high, so I would not see a short-tech, long-energy trading strategy as wise.
But overall, avoiding pricey stock as measured by P/E, price to free cash flow or EV is probably best. The 1970s were not kind to overpriced stocks.
Refugees
Another consequence of this is likely a large flow of refugees heading for Turkey and then Europe.
Palestinians, but also Lebanese, Syrians, and others joining the flow on the occasion. I am really not sure how much Western Europe can accept more before some serious unrest unfolds, it’s not like Italy was not flooded with tens of thousands of African immigrants already.
One more thing to add to the pile of “bearish for EU/Europe”…
Conspiracy Theories
Lastly, I also want to address some of the wilder theories out there.
One idea is that Israel knew about the attack, but let it happen so they have an excuse to flatten Gaza.
If this was true, this has so spectacularly backfired and damaged the army image that I think they still did not know about how it would unroll.
A variant is that it was allowed to happen so Israel unified, after months when it seemed on the brink of civil war. Once again, a little outlandish for my taste.
Another theory is that it is some nefarious plan of the US to:
Go to war with Iran.
Have a reason to abandon Ukraine after its recent failures.
Justify more money printing and a financial reset.
Similarly, all of those could be true, I mean we know for a fact that the CIA and the Pentagon were pushing for Americans to be killed in fake Cuban terrorist attacks to justify an invasion under Kennedy, Operation Northwood.
But really, this seems very far-fetched.
A more likely scenario is Iran seeing a window of opportunity and seizing it.
Seriously, not everything is a CIA/Mossad/Illuminati conspiracy…
This denies that other people in the world have actual agencies and can decide something by themselves.
Lastly, others want to blame Russia or China as the mastermind behind it all. And for sure, Iran has been emboldened by Chinese money and Russian tech. Hammas also seems to use only Huawei phones, as these have no NSA backdoor.
Once again, Occam’s razor would push for the simpler explanation, that the Iranian theocracy, which has promised to destroy Israel for decades, has finally decided this was as good a shot as it would ever get.
Not that Russia and China will really mind seeing the US bogged down in a new war abroad, and at most, they might have been told in advance and chose to let it happen, greenlighted it, or could not stop it, depending on who you ask.
As for Israeli intelligence failure?
Well, a very divided and on the brink of civil war nation was probably distracted enough by internal matters that it missed the external threat. Such things happened a lot in history, not sure what would make Israel special and immune to it.
Conclusion
We can hope this will blow over with minimal damage, but this seems rather unlikely at this stage.
Israeli reaction will trigger more attacks, which will trigger more reactions.
So is the logic of escalation and war.
The need for the USA to appear strong after a series of military failures will also contribute to escalation.
The burning desire of Muslim masses and leaders for revenge against “colonists/crusaders” will also play a big role, especially with the perception of the weakness of the West that has been now firmly installed in the collective mind of the Global South, from military failures, political divisions, and wokeness.
At the end of the day, the winner (or maybe just not the loser) will probably be Asia as a whole, and China in particular.
We might even skip entirely a Taiwan crisis if seeing the situation from Israel to Ukraine, the island decides for a slow rapprochement with China. That would be a defeat for US diplomacy, but probably a win for world peace. Not sure how Taiwanese people would feel about it, but it is really not for me to say.
Of course, all these ideas are valid if we are not already in World War 3 and we are just in 1939 unknowingly. Until then, we can only hope it is not the case…