From Market Economist To Military Strategist

By Peter Tchir of Academy Securities

Technically I’m not an economist, I just play one on TV (CNBC and Bloomberg TV from last Monday).

While I am not a military strategist, everyone in the market and corporate America is being forced to be one, to some extent. Academy is in a unique position to offer unbiased, nonpolitical assessments of the conflict with our Geopolitical Intelligence Group (“GIG”). I’ve lost track of how many conversations I’ve had with our retired Generals, Admirals, and Intelligence officers this past week, let alone since the start of the conflict. We cover a lot of topics during our conversations with clients, with Iran being at the forefront.

Today I will do my best to provide an assessment of the most pressing concerns. The Geopolitical Intelligence Group has a range of opinions, but I think this is a fair assessment of the current consensus view. It is an honor and a privilege to work with the GIG (as well as a competitive advantage in this environment) and all our veterans. Any mistakes or misrepresentations are my own.

That is the same set of conditions that applied to Ceasefire?, which we published earlier this week. That piece remains a useful framework for examining the conditions likely required to reach a deal. However, it was interesting that the President started trying to frame something along the lines of “the regime has changed so much, that it is like regime change.”

After a “manic” week like this week, it is sometimes difficult to go back and review what we published last weekend – Another Manic Monday, but that too is worth re-reading.

Finally, before jumping into today’s report, Academy’s Around the World Report and Around the World Podcast (with General (ret.) Evans and Admiral (ret.) Buss) were both released this week.

Normalizing Tanker Traffic Through the Strait of Hormuz

We will try not to use the words “closed” or “open” in this report, because that doesn’t reflect the real issue. It isn’t about “opening” the Strait, it is about convincing the captains (and owners) of ships that they can transit the Strait just like they used to.

This is an important distinction, from much of what you might hear or read.

From a military standpoint:

There is little evidence that the Strait has been extensively mined. Ships are making it through. It is possible they “know” where the mines are, but it is also possible (and likely) that there are relatively few mines. To the extent there are mines, addressing this threat is precisely what the Littoral Combat Ships assigned to 5th Fleet (with mine countermeasures capabilities and helicopter support) are designed to do.
The main threats remain rockets, missiles, and drones. Especially those fired close to the shore. The time we have from launch, to detection, to interception is crucial to the success of our defenses. The closer the weapon is at the time of launch, the less time we have to hit it.
The U.S. Navy is designed for situations like this. The AEGIS Combat System is specifically designed to defend U.S. ships against such attacks.
Mines, mine layers, small ships packed with weapons, and unmanned surface ships (the naval equivalent of a drone) also pose a threat.

Why haven’t we seen the Navy patrol the Strait? That is the question, as it has become clear that getting shipping back to normal would reduce the leverage Iran has on the global economy. While it is impossible to know (we are not getting all of the information available), here are some of the themes that come up when discussing this crucial question (it really is the $100 or $150 per barrel question).

In all combat situations, there is always a balance between risk and reward. What are the risks of patrolling the Strait today versus striking other targets in Iran? What is the trade-off in risk to U.S. sailors, Marines, pilots, and even the ships today versus what they might be in a day or a week from now? Getting oil (and everything else flowing through the Strait) is a primary economic, and maybe even political concern, but should not drive military decisions.
The caution may be because we have real concerns about how many weapons the Iranians are able to train on the Strait. It may be a function of some elements required to patrol the Strait being engaged elsewhere (we are sending more Marines, 82nd Airborne Division paratroopers, and ships to the region). Some of it might be adapting strategy to the asymmetric warfare threat (more on this later).
The assessment of the GIG is we will get to the point of patrolling or routinely transiting the Strait, maybe in days, maybe longer, but only once the risk vs reward has been justified.

What does it take to convince commercial vessels to go through? In theory, we could set up a “convoy” and send out a naval force (with air cover) and escort ships through the Strait. That is probably what will happen “eventually.” The decision for the Navy to sail in the Strait is very different than that of merchant vessels. The Navy is prepared for this, built for this, trained for this, and it is what those in service signed up to do.

The “realistic” assessment from the GIG that I buy into, is it will take days of demonstrating the Navy’s ability to sail in the Strait without getting attacked before most merchant vessels will even think about trying to do it. Take this job and shove it, comes to mind. This is “just a job” to most of the merchant crews (and even the captain) and they are probably getting paid extra time to wait to cross, so it isn’t like they feel the urgency the market might feel. The insurance plan that the President ordered to be put in place will help (more with the owners than the crew), but I haven’t been able to find out much about the status of the U.S. government-backed plan (Chubb is the carrier being used to provide it according to the reports I’ve read).
The merchant vessels might not even be comfortable if the Navy is getting shot at. This would be another reason for delaying the attempt until there is more certainty that Iran’s capability to attack the Strait is minimal.
Finally, many of the cargo ships are likely going to need to go to port soon. 30 days of eating, and moving around the gulf, take a toll on supplies. The ports they are sailing to, may also not be able to handle them all at once (in the unlikely event they all try to go at once), further limiting how quickly the traffic through the Strait can be normalized.

A lot to think about, but I think that is a realistic assessment of the thought process going on. What is against us, how much safer can we make it, and how do we convince commercial vessels to follow suit.

Asymmetric Warfare

The “concept” is simple – small, cheap weapons, maneuverable, easy to hide, against large expensive systems. Ukraine, first with a plant in the U.K. and now apparently a deal in the Gulf to supply drones, shows how much they have learned in 3 years of war with Russia. Much of which has devolved (or evolved) into drone warfare.

Let’s list the “problems” first:

Shooting down things that cost in the thousands with things that cost in the millions is a very expensive endeavor. It is far from ideal, but not the biggest problem.
Production and replenishment is a more important issue. Have we used a year’s worth of production of some missile systems already? Maybe more. Ships in particular set sail with a limited amount weapons. If we were prepared for a “peer” battle, we were probably expecting to face ships and systems similarly equipped (not as good as the U.S. ones, but similar in concept, cost, etc.). But you cannot just let a “cheap” but effective drone hit you, you need to defend against it. Hopefully, in many cases, other weapons systems that aren’t as costly manage to take out the target. But this need to potentially replenish faster than expected can hamper some efforts.
Really difficult to eradicate. Ballistic missile launches are relatively easy to detect. Ballistic missile launchers are often plodding. Mobile, yes, but not like driving a race car. The launchers are vulnerable after they launch, especially when the U.S. and Israel have Air Superiority (better than Supremacy). Step out of a cave, launch, run back into the cave or through some tunnel system. The fact of the matter is it is difficult to completely stop this threat “without boots on the ground.” This type of enemy is not easy to defeat with range weapons, and is likely why we are hearing more and more about the possibility of landing troops not just on one of the islands, but possibly on the coast where they can more thoroughly clear out the enemy positions (no official decision has been made yet regarding using troops in Iran).

There are some “good” things:

The U.S. military has had drones and has been developing drones for years. That development increased in intensity during the Russia/Ukraine war. It only ramped up further with this new administration. General (ret.) Tata, before starting the confirmation process to be an Undersecretary of War, was very focused on drones. There is no shortage of signals from this administration that they see the need for drones. While a “peacetime” military may be slow to adopt new strategies, that can change abruptly during conflict. Something that might struggle to get acceptance, that might be difficult to fund as it has to come at the expense of other projects, might struggle to get the attention it deserves in “normal” times. This is not normal times, so expect rapid advances in the number and capabilities of U.S. drones in the region. Separately, as discussed last week, if I was Europe I’d set up a drone consortium and start making them as fast as possible, bypassing the expensive military hardware for now. Drones don’t require as much sophistication to produce, so everyone can convert factories and ramp up production relatively quickly.
The U.S. may not want to reveal “everything” we have. China is watching the U.S. military closely. They will be learning how our equipment works in the real world (not just in theory). How much damage does a certain missile do? How deep do the bunker busters go? What sort of things are we defending against easily and what is not working? No need to expose your best stuff, if you don’t think you need to. We might see more deployments of new systems.

My working assumption is Asymmetric FOR NOW.

The U.S. should be closing the gap on asymmetric warfare. Again, is that in time to keep the global economy (especially Asia) from tumbling into recession? I don’t know.

While asymmetric warfare is a distinct topic from getting commercial vessels to sail through the Strait, it is highly correlated, and I’m cautiously optimistic this is being addressed at lightning speed.

Other Risks

The Houthis, until this weekend, had been quiet. Their involvement could open up more shipping problems as they can control a choke point around the Red Sea. It will also cause the U.S. and Gulf Countries to spread their military around.

The Saudi pipeline is extremely helpful, but very vulnerable. While Iran (and the Houthis) might not want to attack production facilities or ships at sea, a pipeline like this might be too tempting to pass up.

Little evidence of cyber-attacks. Maybe they weren’t as good as people thought? Maybe we hit their computer centers early in the war?

Maybe our defenses are that good and we’ve hardened our critical infrastructure? If it is any of the above, it is a solid win for the U.S.
Terrorist activity has not really occurred. Similar to cyber, maybe we have done a great job of identifying and destroying their “sleeper” cells. This has also been a positive and is one form of potential Iranian response we haven’t seen (and hope never to see again).

Humanitarian Relief?

At some point there will be humanitarian issues that need to be addressed in the region. Much of the region imports food. Iran imports food. It is unclear if much is getting through.

This may provide a new “twist” to what is going on there. Who will allow what? Will China get involved? (They did make one statement about possibly being involved in humanitarian missions, but no statement about helping to open the Strait). At least not that I’ve seen.

Strategic Move to Hurt China by Restricting Access to Oil?

This comes up periodically. Was Venezuelan oil first, Iranian oil second, and Russian oil possibly third, all targeted in an attempt to hit China on energy? A way to push back on their control over processed and refined rare earths and critical minerals?

There are some parts of what is going on that fit that narrative well. I’m not sure I buy into it.

If it is true, it does mean the U.S. will need to see this conflict carried out until there really is a change in Iran regarding how they deal with the rest of the world. It does fit with my view that the administration would like U.S. companies to get some access to Iran’s energy business (and would frame that as helping change the regime over time).

Declare Some Form of Victory and Move On

The GIG has talked about shifting from the old model where “if we broke it, we fixed it” to one where “if we broke it, we might come back and break it again.”

It would leave the region in a confusing state. But some of the messaging (from the President and the Vice President) does have the tone - that we are setting up to declare some sort of victory and move on.

Still seems low probability, but it is still possible.

Economic Fragility, Affordability, and Recession Risk

This will be a separate report in its own right, but nothing that we haven’t been writing about. Supply chain, and economic fragility is real, expect to see cracks soon.

Affordability is an issue across the globe, not just domestically. Affordability has only gotten worse. The “working poor” concept is getting some discussion as it would be the start of a very different type of recession. Job loss recessions, we have a playbook for. People with “good” jobs who cannot afford a reasonable lifestyle is new. Not good.

Is recession for Asia (ex-China) and Europe my base case? Not quite, but possibly only because I haven’t had the time to think about it.

I don’t see a recession for the U.S. (or China), but it is certainly something we should be admitting is a possibility as not only does the conflict continue, but also the willingness to target energy, refiners, smelters, etc., is increasing and will take a toll even if we come to a resolution in the coming weeks. A world where the resolution is ideal or suboptimal won’t even make a difference as the damage is done and permeates throughout the global economy.

Bottom Line

Expect bond yields to start acting “normally” in a risk-off environment. Friday morning may have been peak unwind/capitulation and peak inflation fear. Friday afternoon might have been the market deciding to at least think about recession and economic slowdown risks.

Very cautious on risk here.

Could we miss a big relief rally? Possibly, but I think this time (unlike last Monday/Tuesday) the relief rally will require credible evidence that a resolution is coming.

Because of that, we will have time to adjust our positioning. Until then, be cautious on risk, add some duration.

Credit did feel weak on Friday, which would be a new thing to worry about (credit, not just private credit). Spreads were leaking.

So far the equity sell-off hasn’t required much help from credit, but if credit were to turn more negative, we have some serious downside risk for equities. From our Is Credit Whispering or Screaming? and Credit – A Little Louder Now – we’ve identified how we see a path to credit widening. It hasn’t been a primary concern, but we need to revisit that “complacency” as the risks of an economic downturn are increasing.

I think I ended sounding gloomier than I feel, but this is a very tricky environment, and military and politics will drive the next 5% on stocks.

Hopefully that 5% will be to the upside as ships start sailing through the Strait sooner than the market is expecting! (There, I did finish with some optimism, even if it isn’t how I’m positioned).