Fog of War

Fog of War | Daily Tribune

The world has seen several wars over the past five years. The war against the Covid-19 virus, the Russia-Ukraine war, and now Israel versus Iran and their proxies. And let us not forget, we have an ongoing trade war.

In such an environment, there is so much uncertainty for everyone – financial markets and the economy included. Remember, everyone is trying to maximize the present by making the best choices for the future. And war is one of those factors that cloud the future.

Carl von Clausewitz, a Prussian general in the 1800s, described this uncertainty in his book Vom Kriege (About War) as the fog of war. Investors and policymakers need to deal with this uncertainty as they navigate the economy and the markets and make what economists would consider “sub-optimal” outcomes.

Given the theme of war, what would military commanders do that investors can apply? To lift or pierce through the veil that prevents us from seeing ahead, the military enhances its command and control with intelligence, surveillance, target acquisition, and reconnaissance (ISTAR). In investment parlance, this is the same as research, but the processes are different.

The goal, however, remains the same, which is to enhance the situational awareness of the decision makers. Investment research takes a page from science in the use of building and models to understand the dynamics of an ongoing situation.

Over the past three weeks, the biggest fear in the market was inflation induced by high oil prices because of the situation where Israel launched an air attack against Iran; Iran retaliated with its own barrage of missiles; and the US sent B2 bombers loaded with bunker-buster bombs to destroy nuclear facilities inside Iran.

To be sure, these events were the topic of global headlines. Oil zoomed past $70 per barrel and was threatening $80 per barrel, while domestically petrol prices were hiked by more than P1.50 per liter across products.

After the bunker-busting bombs were dropped, a ceasefire was called and oil fell like a knife back below $70 per barrel and now there are calls for a rollback in pump prices. All this happened in less than a week. The story had more intensity than an Asian drama streaming on Netflix.

But that is what the fog of war brings – uncertainty and volatility.

Based on my model, rising oil prices were not a strategic threat. While it may seem to have the benefit of hindsight, my model asked the question of whether there was a risk of conflict contagion because the strategic effect of putting oil prices on a sustained uptrend requires that the production and logistics of oil from the Middle East be threatened.

The model assessed that the probability was low (not very low, but low) because the areas that are of material risk are south of Israel and Iran. In other words, the guns are pointed to the east (for Israel) and the west (for Iran). For the probability of conflict contagion to rise, the guns would have to be pointed south.

For a moment, they were, when Iran fired 11 missiles towards a US airbase in Qatar in retaliation for the bunker-buster bombs. All except one missile were intercepted or destroyed. The important thing is no other missiles followed, making this attack a symbolic one rather than a strategic change in the dynamics of the conflict.

Can the dynamics change? Absolutely, but the probability is very low, in my view. One scenario that was going around was the US goes to war with Iraq. While it is true that the US Congress can declare war, it would take a painful incident like the sinking of the USS Maine or the attack on Pearl Harbor to trigger this. Congress can authorize a military force like in Vietnam or Iraq, but this too must have a catalyst that agitates the public consciousness.

For now, inflation is safe from the threat of oil prices rising back above $90 per barrel in a sustained manner. Volatility is likely to be with us in the next couple of quarters on geopolitics, but the current economics of crude oil are still favorable to us. Natural gas, however, may be a different story.

As a final point, the Middle East is a serious issue because it is host to many Filipinos and any conflict in the region has a social cost that can be too high to bear.

However, the main uncertainty that fogs investors’ outlook are the changes in US policy under President Donald Trump. This one is harder to model and can shake financial markets both short-term and strategically. For now, though, keep your eyes peeled and portfolios diversified.