How will the conflict with Iran impact global equity markets?

On December 30th someone tweeted the headline:

IRAN WARNS U.S. ITS MIDDLE EAST DOMINANCE IS OVER AFTER NAVAL DRILLS WITH RUSSIA, CHINA

I replied and shared the link to the Newsweek article about the threat from Iran:

According to the NPR timeline of Iran events, it started a few days sooner.

Friday, Dec. 27: Attack near Kirkuk

Militia group Kataib Hezbollah attacks the K1 military base near the Iraqi city of Kirkuk with rockets, killing an American contractor and wounding several American and Iraqi personnel. Kataib Hezbollah has ties to Iran. It has denied orchestrating the attack.

In response:

Sunday, Dec. 29: Trump orders some airstrikes

Tuesday, Dec. 31: Embassy compound stormed

On Tuesday morning, Iraqi supporters of Kataib Hezbollah begin storming the U.S. embassy in Baghdad. The violence escalates, with militia members attempting to enter the embassy, starting fires and damaging the outside and a reception area of the embassy.

The conflict in Iran escalates:

Thursday, Jan. 2: Esper’s warning; Soleimani killed

Esper gives a statement emphasizing that the U.S. “will not accept continued attacks against our personnel & forces in the region.” He also sends a message to U.S. allies to “stand together” against Iran.

U.S. Marines are deployed:

Thousands of Marines Head to Middle East on Navy Ship as Iran Pledges Retaliation

A Navy amphibious assault ship with thousands of Marines on board will skip a planned training exercise in Africa to instead head toward the Middle East as tensions there spike.

Now, infantry from the U.S. Army:

750 soldiers with 82nd Airborne headed for CENTCOM, additional 4,000 troops expected to deploy as Iran tensions mount“At the direction of the Commander in Chief, I have authorized the deployment of an infantry battalion from the Immediate Response Force (IRF) of the 82nd Airborne Division to the U.S. Central Command area of operations in response to recent events in Iraq,” Secretary of Defense Mark Esper said Tuesday evening in a written statement.

Just like that, we go from a relatively peaceful time to what may become another war in the middle east if Iran doesn’t stand down.For some of us, these things hit closer to home when we know those being deployed. But, you don’t sign up to be a U.S. Marine or Army Ranger expecting to get through your tour without deployment and the possibility of combat. As Americans, we are fortunate for our Sheepdogs yearning for a righteous battle: On Sheep, Wolves and Sheepdogs.

How will the conflict with Iran impact U.S. and global equity markets?

I don’t know.

Neither does anyone else.

But I do have an idea, and it’s pretty obvious it isn’t positive news, though we never know for sure how the world markets will react to any news.

Although I am regarded as a “global macro” investment manager, I don’t focus so much on the “macro” as in “macroeconomics” as I do the direction of price trends and their volatility.

Economic indicators, as well as fundamental evaluations, have the potential to be very wrong and stay wrong. If you believe ABC stock is cheap at $50, you really believe it cheap as it falls -50% to $25 and then what if it drops to $5? Not my cup of tea.

That dog don’t hunt.

I focus instead on directional price trends.

The concept is very simple:

  • If I’m long an asset that is trending up, it’s good.
  • If I’m out of assets that are trending down, it’s good.
  • Or, if I’m short assets that are trending down with the potential to earn a profit from the downtrend, it’s good.

It’s easier said than done, so it isn’t so simple to operate. For example, what time frame is a trend? Why one time frame over another? It all has to be quantified to determine what is most robust.

And you know what? that changes, too.

It’s not as simple as running a backtest to determine the best signals, parameters, and time frame to apply them to and then expecting the future will be just like the past. Past performance doesn’t always indicate future results. So, this requires work. It also requires me to keep it real.

I’ve been pointing out for a few weeks that a volatility expansion seems imminent. Since I first observed it, the S&P 500 index had a minor decline of 2-4% before continuing its uptrend. The U.S. equity market has been bullish. But, here we are again. The price trend has drifted above its average true range channel. A price trending above its average true range is positive, but when it stays above it, it can also result in mean reversion. That is, the price may drift back toward the middle of the volatility channel like it did early December.

spx spy ATR volatilty expansion asymmetric

So, on a short term basis, the stock indexes have had a nice uptrend since October with low volatility, so we shouldn’t be surprised to see it reverse to a short term downtrend and a volatility expansion.

For those who were looking for a “catalyst” to drive a volatility expansion, now they have it.

We don’t know what’s going to happen next in Iran, but what I do know is exactly how I’ll respond to changing price trends.

I predetermine my exits in advance to cut losses short.

I predefined my risk and know how much risk exposure I have at any time.

Since I do this for all of my positions, I know how much risk I have accepted in each individual position, but I also know how much portfolio risk I have for drawdown control.

As a simple example, if I had 15 positions across global markets and each of them has their own individual exit points where I would sell to reduce exposure, then I can use the summation of that risk at the portfolio level to predetermine a drawdown limit. Of course, any hedging positions such as a short S&P position, reduce the portfolio risk of the longs, too. And, not all of these global positions are necessarily driven by the same return drivers, so they may not all be correlated. So, they may not all trend up or down together. For example, when the S&P 500 stock index has had a down day of -1% or more the past fifteen years, the Long Term U.S. Treasury has gained an average of 0.80% on the same day. An even more asymmetric example is on the same day the stock index fell -1% or more, the long volatility index-based ETFs may have gained 5% to 15% on the same day.

It’s times like this when my process and systems become more obviously necessary.

For everyone else, there’s buy and hold with no limit to their downside loss.

That dog don’t hunt, for me. 

Let’s hope for peace in the middle east, but if they don’t want peace, Godspeed to our Troops as they enter and embrace the unknowable. 

Semper Fidelis.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

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