Learning from War

Not investment advice.

The Iran war is roughly 75% over. There is approximately a 25% probability of escalation and another significant spike in energy prices.

Months in, a few key observations stand out:

1. It is wiser to trade the consequences of the war — primarily higher inflation — than to trade the war itself.

This is because:

a. There is little edge in trying to predict near-term moves by Trump or Tehran. Questions such as “How exactly will the US incentivize Qatar to pay off Iran to reopen the Strait?” or whether either side will overplay its hand are coin flips with wide bid-offer spreads.

b. The oil market shows signs of informed positioning and insider trading. Large, well-timed bets have appeared ahead of key White House announcements. As a result, heavy buying of 5,000+ $110 calls this Friday afternoon triggered concern. After the initial spike, oil has gone roughly sideways for two months amid persistently high volatility — a difficult combination for most portfolios.

c. In contrast, the transmission mechanism from oil to the broader economy is clearer. Sustained higher oil prices feed directly into higher inflation. With oil inventories already low, the risk of another spike remains live. As bond markets have sold off (shown below) and real yields have risen, inflation-linked bonds have become more attractive as are outright short positions in nominal bonds. Markets are currently pricing inflation as ultimately contained.

d. A prolonged conflict also drives higher military spending, which is fiscally expansionary and therefore negative for bonds.

Some countries, like the US, are less exposed to the war, while others, like Europe, are more exposed. This creates the opportunity for differential bets, long one shot the other.

Even if the conflict de-escalates, the combination of elevated inflation, continued fiscal impulse, and massive AI-driven capex spending should keep upward pressure on both growth and prices.

2. The AI story is also fundamentally a military story.

a. While technology has always played a role in warfare, today’s AI represents a far more powerful leap than canals, railroads, or even the internet. AI is almost like nuclear energy.

b. The United States holds a significant structural advantage through its dominance in leading AI models and advanced chips even if it is far behind Ukraine in figuring out how to apply this knowledge on the battlefield. The US AI lead puts adversaries like Iran, Russia, and China at a clear disadvantage. However, aggressively pressing this technological edge carries risks. Hubris could provoke unpredictable counter-reactions. The more effectively AI helps the US and its allies win battles, the greater the incentive for China to act aggressively on Taiwan before the gap widens further, for instance. This at a time when the supply chain for robotics is entirely dependent on China.

c. Within the defense sector, AI is creating the same pattern of creative destruction seen elsewhere in the market. Just as software stocks were disrupted while semiconductor memory stocks surged, capital is now flowing toward next-generation defense companies while leaving legacy military contractors behind.

In short, war is now a feature not a bug and we all need to learn how to manage through such turbulence. This week, Russia sent a clear warning signal that the Baltics may be next on their agenda.

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