The Markets Are Underpricing the Risks of 1914

by | Oct 15, 2023 | Armed Forces, Biden Administration, Finance, Hamas, Iran, Islam, Israel, Politics, Terrorism, USA, War

In the summer of 1914, none of the Great Powers realized that they were sleepwalking towards disaster. A singular regional event, the assassination of the Archduke Franz Ferdinand of Austria by a radicalized Serbian nationalist, would prove to be the proverbial spark that set the whole European house aflame through a daisy chain of national actions and reactions. Each country took steps in its own perceived self-interest that it thought were rational, reasonable, and proportionate. Armies were mobilized, treaties were honored. Within a year, the continent was engulfed in an armed conflict then unseen in the history of man. The long Great War and the resulting devastation of Europe was inconceivable to Europe’s leaders, as none understood the interconnectedness of their actions with those of others, nor did they appreciate the implications of the technical advances of the age.

We are in a similar moment of great risk. Hamas’s surprise terrorist attack on Israel brings the expectation of a certain and devastating response. Whether proportional or not, such a response will inevitably invite further reprisals and the potential widening of the war to involve not only regional players such as Lebanon and Syria, but also the great powers aligned with them, whether the U.S., Iran, or others. We are quickly ratcheting up the escalation ladder and are in grave danger.

Iran, long seeking as a matter of official policy the complete annihilation of the “Zionist entity,” i.e., the state of Israel, has acted to destabilize the normalization of diplomatic and commercial relationships between Israel and its more moderate Muslim neighbors, including the United Arab Emirates, Bahrain, Egypt, and Saudi Arabia. Iran has been the primary financial and logistical sponsor of Hamas and Hezbollah. With the Biden administration’s relaxing of Trump-era U.S. sanctions on oil exports, the radical Islamicist government in Iran is now flush with cash and armaments, and is posturing for war. Specifically, Iran has threatened to intervene should Israeli military forces enter Gaza, a step which now seems inevitable.

The Syrian army has mobilized following Israel’s bombardment of airports in Damascus and Allepo. Rockets have crossed into Israeli territory from both Lebanon and Syria. Qatar has refused to eject Hamas leadership and welcomed the Iranian Foreign Minister to meet with them there. The U.S. is moving not just one but two carrier strike groups into the Eastern Mediterranean. Even if this is just posturing, the probabilities of a conflict event with U.S. forces—whether accidental or intentional—has increased meaningfully.

The markets are ignoring all of this. In the week following the terrorist attacks on Israel, the stock and bond markets essentially shrugged their shoulders. Traditional risk-off assets such as gold and commodities moved up, but not substantially. The dollar was flat and Bitcoin fell. Even oil, perhaps the global commodity most at risk, failed to regain the highs seen only a few weeks before.

The markets seem to be signaling that this will all blow over, that cooler heads will prevail, that perhaps China will intervene diplomatically as they have successfully done recently in the region. In other words, the markets are pricing for a best-case, “soft landing” scenario. This is a fantasy.

Now is not the time to ignore the warning signs. While events may not develop as severely or as rapidly as they did in 1914, the situation is unlikely to end quickly or easily. The odds are that this conflict expands, and that the world is thrown further into turmoil.

There appear to be very few investment safe havens in this environment. Cash is certainly one, with short-term Treasuries now yielding above five percent. The U.S. is now committed to support both Ukraine and Israel, in addition to replenishing its own recently depleted armaments inventories. While I hate to say it, defense industry stocks, up as much as ten percent this week, should also continue to do well. And, if indeed the conflict widens, oil will inevitably run.

Whatever one’s religious or political views, we should all heed the words of the psalmist and pray for the peace of Jerusalem.

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