A Strategic Miscalculation

First, I will get the politics of this Iran fiasco out of the way before I focus on markets:

This morning "Secretary of War" Pete Hegseth gave a briefing telling the American public that the U.S. is retaliating for 47 years of "one way" aggression by Iran against the United States. Nothing could be further from the truth. Iran has never attacked the U.S. on its own soil. Whereas the U.S. has attacked Iran twice just in the past year. In addition, the U.S. funded the Iraqi proxy war against Iran from 1980 to 1988 which killed hundreds of thousand of Iranians. Then there are the decades of economic sanctions that have impoverished Iran, Hegseth didn't mention. He also forgot to mention that U.S. military intervention in the Middle East has been a complete and utter disaster for over four decades now. There is no justification for this war.

That said, let's focus on the facts that we have now, that we didn't have last Friday:

1) This war could last several weeks or longer:

"He (Trump) said the administration expects the campaign to last four to five weeks, but "we have [the] capability to go far longer than that."

2) Escalation could include troops on the ground:

"In an interview earlier in the day, Trump refused to rule out the use of ground troops, saying he wouldn't hesitate to deploy them "if they were necessary."

3) Trump thinks this war will be easy:

"Mr. Trump said the U.S. military will "easily prevail" over the Iranian regime."

4) The exit criteria for the war is totally undefined:

It will be at Trump's discretion to decide when it's over. Which means that it is very unlikely to achieve real regime change. If anything, the assassination of Iran's leader will further tighten the paranoid police state the country has been operating under. There are many hardliners in the Iranian power structure who are crazier than the leader Khamenei who was just assassinated. This could make Iran a far more dangerous adversary with a "nothing to lose" mentality.

Which gets us back to markets:

The best case scenario for markets is for Trump to TACO sooner than later and declare victory. However, ironically as long as markets remain well bid and complacent, that is far less likely to happen. From the article above:

Trump:

"Somebody said today, they said, 'Oh well, the president wants to do it really quickly. After that, he'll get bored.' I don't get bored. There's nothing boring about this."

Therein lies the strategic miscalculation - either markets go RISK OFF and force Trump capitulation OR Trump continues to escalate until true disaster strikes such as an aircraft carrier gets sunk and then Trump will double down and send in troops. That's how the Vietnam war got started - it was called the "Gulf of Tonkin incident" - U.S. ships were reportedly attacked in the Gulf of Tonkin, which led Johnson to seek Congressional approval for a full scale invasion. If there is a "Persian Gulf incident", markets will be bidless.

But it gets worse, because even before the war started markets were already falling apart. Sector after sector was collapsing due to "AI panic". And then late last week, financials went bidless due to the spreading private credit crisis. Which means that this Iran war has merely been an excuse for hedge funds to cover their shorts.

I would remind everyone that the last bank run was in March 2023 and since that time loans to shadow banks (NDFIs) have grown by almost $1 trillion. More than doubled.

What we are witnessing is a series of short covering rallies before the wheels come off the bus, deja vu of March 2023:

As we see below, post-invasion U.S. Momentum Tech remains parabolic, but Nasdaq Hindenburg Omens called the last two tops perfectly.

Ironically, while U.S. markets have been able to ignore all of their own risks - AI, private credit, Iran - the rest of the world is not able to ignore these risks. There were currency dislocations all over the place last night. Turkey, India, Indonesia to name a few.

When Europe opened last night the S&P futures were down over a 100 points due to the selloff taking place across Europe:

This was the worst day for European stocks since last April. My opinion is that similar to the pandemic, U.S. gamblers will ignore overnight risk until they final implode. Which could happen any day now.

In summary, February ended the longest monthly winning streak (10 months) for global markets (w/U.S.) since the Iraq war started at the Y2K lows of 2003. Back then, there was EXTREME risk aversion both towards the imploding Y2K Tech bubble and towards the impending Iraq war.

Today there is no fear of a massive Tech bubble and zero fear of Trump's war against Iran. Therefore to believe these two set-ups for a long-term rally are the same, is final proof of a massive Moron Bubble.