Here's Context Into How Iran Could Respond to Redrawn Lines in the Sand

The events of last week altered the geopolitical landscape the most in years, if not decades. At Academy Securities I work with 13 retired generals and admirals who have helped form my view on this subject, which is important for all market participants to be thinking about. While we focus on the markets and the high-level geopolitical risk, let's not lose sight of the brave men and women who stand in harm's way in their service to the country. Academy's View Before Last Week As background to see how we have been thinking about Iraq, you can read this edition of Around the World. Reading How Iran Fights provides useful background into what the Iran Revolutionary Guard Corps (IRGC) can do and how it operates. Overall, we've had two key themes regarding the region: Economic sanctions have been working. The U.S. and our allies have been patient and prudent in retaliating against Iranian aggression. Economic Sanctions Have Been Working The escalation in the region has occurred precisely because economic sanctions have been working. This may seem like a bold statement, especially as I've seen many people advocating that the strike was a sign that sanctions have not worked. In the immediate aftermath of our attack, some focus will be lost on the economic side of the equation, but all the intelligence I receive (corroborated by my own sources) leads me to believe sanctions are working and will continue to work. Caution in Retaliation After an air strike on Iraqi soil that killed senior Iraqi and Iranian military leaders it might be difficult to argue that we have been cautious, but I think as we take a step back that statement may not seem that far-fetched. Since Iran escalated over the summer and in the fall with an attack on Saudi oil production, we could have retaliated in many ways. I highly doubt any would have been as effective and precise as what we just did when the target of opportunity presented itself. While killing Soleimani may not be the equivalent of cutting off the head of a snake (yes, he will be replaced), it is crucial to remember that this terrorist has a long history of successfully coordinating attacks on the U.S. and our allies. Losing him could be a very serious blow to Iran's capabilities. Redrawing Lines in the Sand Is Risky Quite simply Allowing lines in the sand to be crossed reduces near-term risk of confrontation but creates more dangerous long-term threats as enemies become emboldened. Reinstating lines in the sand adds some near-term risk but should reduce risk over the longer term. Enemies don't want lines in the sand redrawn. They liked the status quo of operating with some degree of immunity. It isn't just Iran and its proxies that have been affected by this redrawing of lines. Certainly, North Korea's Kim Jong Un and Syria's Bashar Hafez al-Assad, among others, took notice of what just happened. What is the line? That is a fair question. Some are asking if we did too much. Some are asking if we shouldn't have made it clear in advance that a line had been crossed. Did we redraw the line too aggressively? Did President Trump get the right approvals? Are our allies on board? Is the risk of war now too great? Is this an act of war? Can we justify this as an attack against terrorism? These are all valid questions and there are no easy answers. This was clearly a big step, though I stick to my earlier argument that given our range of options and the attacks we've faced our response seems measured. Also, while this action has likely created some new risks, let's not forget that we have been facing risk for a long time and not combating those risks created new risks. Expect Rhetoric You are going to hear a lot of rhetoric from both sides in the coming weeks. Both sides need to appeal to their populace. How much rhetoric turns into action remains to be seen. Next Actions: Iranian Military The reach of the Iranian military is regional. It cannot extend its reach to our shores (although a terrorist attack on U.S. soil cannot be ruled out), nor can it expect to win a head-to-head military confrontation with the U.S. It certainly cannot expect to win against the combination of the U.S. and our allies. The Iranian leadership is aware of that, alhough we cannot discount some paths that may seem illogical to us but logical to the Ayatollah. There can be attacks against our military forces in the region (those threats have already been made), but Iran would need to expect retaliation and the success of this past strike will weigh heavily on its decision. The most likely outcome, based on Academy's consensus, is a continuation of attacks on allies using proxies -- just enough to appease their people while not risking escalation that causes regime change. Not every general agrees with this specific view and the range of possible outcomes is large, but from all my conversations I'm comfortable saying this is the near-term consensus. Next Actions: Cyber As we've discussed in the past, Iran has very strong state-sponsored cyber capabilities. We understand their capabilities and have done a lot of preparatory work to defend against them. We've written about the Iranian cyber threat and believe that analysis is still applicable. Cyberattack on Military Installations. Highly unlikely to be successful and it carries an extreme risk of retaliation. Iran should expect both cyber and kinetic responses (use of force) if it initiates any such attack. We believe we will be able to attribute the attack accurately and would respond as such. With the lines in the sand being redrawn, Iran would have to be even more concerned about retaliation. Cyber Attack on Financial System/Electric Grid. According to our generals who have been intimately involved in the U.S. Army and Department of Defense cyber strategy, Iran is constantly probing our systems. Between what we can do at the national level and the investment that companies and industries have made to harden themselves against cyberattacks, there is a reasonable degree of confidence that any such attack would not be successful. At the military level, deterrence plays a big role. Traditionally, it has been more difficult for companies to retaliate against a nation state with cyberattacks and impossible to launch a kinetic response, though the willingness of this administration to launch such attacks in defense of an Iranian attack seems high (especially with the redrawing of lines). As with anything with cyber, there is uncertainty, but there is a lot of reason for optimism that we would prevail against such an attack. Cyber Attack on Our Allies. The most likely course of action is still an attack against an ally that has spent less time and energy on hardening itself against cyber threats. Saudi Arabia likely presents an easier target with less ability to retaliate effectively. The cyber threat is real, but likely to be contained. Buy Oil and Energy Stocks and Bonds With a view that tensions will remain elevated but highly regional, look for energy prices to remain elevated, especially Brent crude. I prefer owning energy-related stocks and bonds more than the commodity as they have lagged for so long and investors are too underweight the sector that they could see very strong returns very quickly, even if oil prices themselves only stay near-current levels. This fits well into a theme that we already had coming into 2020 - buy cyclicals. I'd avoid bonds in the region. I don't think they are fully pricing in the risk yet. Bottom Line: Scary but Real Opportunity If I am correct in how I've interpreted what our Geopolitical Intelligence Group is saying, we will be able to return to a more typical macro report sooner than later. While we need to expect heated rhetoric and potential Iranian retaliation, the risk of escalation is contained and there are a surprising number of potential positive surprises that arise from redrawing lines in the sand.

Here's Context Into How Iran Could Respond to Redrawn Lines in the Sand

We handicap the potential impact of responses that could range from military actions by Iran and its surrogates to cyberattacks against the U.S. and its allies.

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