Middle East Asymmetric Risk
There was a time when my biggest fear was that Iran would not be a rational player following the invasion of Israel of Gaza. That Iran would take the opportunity to launch a war against its avowed arch enemy, rather than rely on its proxies. That fear proved unfounded. Fast forward 6 months, and we find ourselves again facing the risk that Iran launches an all-out attack on Israel - with the aim of destroying it - but only if Israel “retaliates”. Such an attack, according to many pundits, would effectively start WW3. I can’t think of any moment in recent history where we face such asymmetric risk to the downside in the span of a week. I say a week because it is likely we can breathe easier if Israel decides not to launch some kind of attack on Iran in the coming days for its barrage of 300 or so projectiles and drones this past weekend. I put the word “retaliate” in quotations because in this case, it isn’t clear if a military response by Israel constitutes retaliation. If one is to believe Iran’s version of the events, it wasn’t until Israel bombed Iran’s consulate in Damascus - killing two generals and 15 more - that it decided to launch an attack on Israel. In Iran’s eyes, Israel struck first in terms of violating sovereign land and so its actions was true retaliation. While Israel demurred on commenting on its role in the bombing of the consulate, the world community assumed that it was in fact Israel who was responsible for the attack. What should we have expected Iran to do?
If one thinks back to the U.S. assassination of Iranian General Qassem Soleimani in 2020 and the consequent events, it should be of no shock that Iran retaliated against Israel the way it did for the recent assassination of two of its generals. Trump ordered the assassination of Soleimani in 2020 only if Iran’s actions - through its proxies or not - resulted in American deaths. When one American - a contractor - was indeed killed, the assassination of Soleimani was carried out. The Iranians responded by bombing U.S. military housing in Iraq, which resulted in modest damage and injuries. Trump and Iran apparently called it even at that point. What’s important about the attack is that Iran basically notified the U.S. that an attack was forthcoming. The U.S. took preventative measures and so minimized the damage. In the current crises, Iran acted similarly. It called Turkey - a member of NATO - to notify them of the impending attack on Israel. Surely, Iran assumed the news would be delivered to the US and its allies. Everyone was ready and waiting. Thus Israel and all its allies - even some not so allied - neutralized 99% of all of Iran’s incoming projectiles. But unlike Trump in 2020, the military branch of Israel appears far from calling it even. To its leaders, It seems the scope of the retaliation by Iran is of such magnitude that calling it even is not possible. The end result of the attack doesn’t matter it seems. Biden has tried to convince Netanyahu and his cabinet to focus on the end result and that they should consider the events of the past few weeks a net “win”. Israel attacked the Iranian embassy and killed 17 people, including two generals. Two weeks later, Israel - with the help of its allies and a phone call from Iran - thwarted Iran’s response and sustained minimal damage and one serious injury to a civilian. Trump is, if anything no pushover, and for Netanyahu to follow his example seems like a reasonable course of action. But what is in the interest of global peace might not be what is best for Israel in dueling with Iran, a nation that in the past has vowed to destroy it.
The fact that no military action has been taken by Israel against Iran so far appears to have provided little comfort to investors. The S&P is down about 1% from the close on April 12 - the day before the Iranian attack - and appears to be headed for a down day today. Investors have all reason to be nervous. The near-term (and perhaps far longer) outlook hinges on what Netanyahu decides to do in the next 5 days or so. That’s far from a comfortable place to be in. It does seem reasonable to assume that with every day that passes without overt military action by Israel, the chances of it actually happening diminishes. An assessment of our holdings indicates that 27% of the portfolio is exposed to asymmetric and significant downside risk. As a hedge, I’ve elected to purchase the 4/23/2024, $500 SPY puts on these positions. By early next week, based on Israel’s actions and rhetoric, we should have a far clearer picture of Netanyahu’s intentions. In fact, it might become painfully clear.
