🍔End Phase of the War

Light at the end of the tunnel...

Welcome back to MktContext where we study the US economy and time the stock market.

The market entered a downtrend this week as investors are now realizing the Iran war will last much longer than initially expected. However, we believe we’re now entering the end phase of the war.

The SPX selloff is already well advanced in both time and price. We are viewing this as a pullback within a bull market, and expect higher highs to come next.

But there’s a catch. The US needs to make one final push in Iran before withdrawing. A devastating climax, the goal of which is to ensure Iran can’t fight back. This will likely happen within the next two weeks.

We outline what all that means for stock markets. If you are in cash right now, this could be the dip to buy.

Today’s topics: Updates on Iran war, light at the end of the tunnel, end phase, implications for stock markets, FOMC review, gold failing as safe haven, oversold technical conditions.

Escalation in Iran war

The war in Iran continued to escalate. Two reasons why this week was significant: 1) energy infrastructure was hit for the first time, and 2) natural gas facilities have been hit for the first time.

Iran’s South Pars natural gas field was hit, as was Qatar’s LNG export facilities, Saudi Arabia, Kuwait, Bahrain, UAE, and some others. Up until now, strikes were mostly contained to military targets, but it appears that gloves have come off. Trump has called for a de-escalation of strikes against oil and gas facilities.

Notably, this marks the first strike on Iran’s oil production facilities. In turn, the Islamic Revolutionary Guard (IRGC) announced retaliation is not yet finished, and issued a list of energy sites across the Gulf that they would target.

The strike on Iran’s facilities was done by Israeli forces without the explicit approval of the US. A stark reminder that the US and Israel are not perfectly aligned. Trump wants a limited win and is indifferent to long-term instability; Israel wants prolonged involvement by the US to bog down Iran. The outcome of the war may be outside of the US’ control.

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The US’ dilemma

The “quick end” narrative is failing. Trump initially characterized this war as a “minor excursion” against a military that was supposedly “obliterated”, and that it would be over in a matter of days. Those claims are now contradicted by the President’s desperate pleas for NATO and China to intervene.

The US now finds itself in a quagmire similar to Iraq and Afghanistan. It has overwhelming military dominance and are exacting a tremendous toll. But the opponent is surviving and fighting back with small strikes and guerilla warfare.

Trump’s remaining escalatory options are all bad. He can try to secure the Gulf indefinitely, but this is expensive and may not even be possible. He can invade and hold Kharg Island, said to be Iran’s financial lifeline, but the costs would also be high, as would be overturning the regime.

The “least bad” option is a diplomatic offramp — declare Iran’s military degraded, concede control of the Strait, and let Gulf countries/oil importers deal with the fallout. Though embarrassing for Trump, this would be more favorable than a prolonged, unwinnable war.

Light at the end of the tunnel?

We continue to believe US involvement in Iran will last weeks, not months, let alone years. This has always been the timeline maintained by Trump, and we outlined reasons why he is incentivized to stick to this plan.

Interestingly, the market (as measured by options pricing) is losing faith in this outlook and is starting to assume this war will last for months longer. An understandable reaction, since Trump repeatedly saying “almost over” has always led to further escalation from both sides.

Nevertheless, there were some positive developments this week. Israeli Prime Minister Benjamin Netanyahu announced they would no longer target Iran’s energy infrastructure, and that “the war will end way faster than we think”. He also claims Iran no longer has uranium-enrichment capacity, and committed to helping reopen Hormuz.

Shortly after the market closed on Friday, Trump published a Truth post claiming that Iran’s military is severely hampered, and the US is considering winding down the mission:

That led to stocks bouncing sharply higher near the close, after an ugly trading session (made worse by quad witching expiry of options and futures, which often leads to unusual volatility).

Friday intraday trading

By now, the market knows not to take Trump at face value. As we’ve said before, the administration has been talking up markets, keeping a lid on oil prices, as the invasion reaches fever pitch. This week was perhaps the first time that the market realized this will be a protracted battle.

Going back to Trump’s Truth post, the important line is this: “The Hormuz Strait will have to be guarded and policed by other nations who use it”. This effectively gives Trump a plausible withdrawal path without the laborious work of actually keeping the Strait open. He’s saying, “Our job is done here, it’s now others’ job to keep it going.”

It also gives Iran some leeway to continue controlling the Strait, perhaps even levy a toll on traffic. A concession that Iran may quietly accept, as it cements their stranglehold on world oil (the strongest military in the world could not take it) while extracting economic rent from the entire Gulf region.

But here’s the catch: Before withdrawing from the region, the US needs to make a final push to ensure Iran’s offensive forces are neutralized. This could be a ground invasion, a takeover of Kharg Island, or some other devastating climax. The goal is to ensure that Iran cannot fight back once the US withdraws. This will likely happen within the next two weeks as thousands of Marines are en route to the Gulf.

This is Trump’s true meaning of “very close to meeting our objectives”.

End phase of the war…

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• Now entering the end phase of war

• Implications for stock markets

• FOMC looks through inflation

• Gold failing as safe haven

• Technical analysis - Oversold

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