#1019 - How Global Conflict Impacts Markets | With Jacob Shapiro

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0:39Welcome to Real Vision Daily Briefing. It's Friday, April 19, 2024. I'm Ash Bennington. Today, I'm joined by Jacob Shapiro, Director of Geopolitical Analysis at Cognitive Investments. Jacob, welcome to the show. Thanks. And we got to stop meeting like this with all these fires going on everywhere. Yeah, Jacob, let's just jump right in here and talk about what's happened over the last 24 hours. indeed over the last week, unprecedented events in the Middle East. For folks who may not be following the story as closely as you are, please give us the context for what happened as well as the latest news over the last 24 hours.

1:13Well, as I like to joke, I mean, the context here can get as long as you want. Like we can go back to the ancient Israelite and Persian empires and talk about how all of the things that are happening today have, you know, sort of been laid by millennia of history. But the sort of proximate things here, or at least the recent signposts that we need, October 7th, you get the Hamas attack attack against Israel. You get Israel invading Hamas as a result of that and also hitting Hezbollah and some of Iran's other proxies in Syria and things like that. Fast forward to April and you have Israel launching an attack in Syria at an Iranian consulate or embassy, sort of unclear which it was, but killing a major Iranian military official in that attack.

1:54And Israel didn't warn anybody about that attack. It was sort of a, they hit them and the United States wasn't so happy that they didn't get the warning. And Iran felt like it needed to respond. So last weekend, Iran decided to send hundreds of missiles, drones, rockets to attack Israel. Israel fires up its missile defense system and manages, with the help of countries like Jordan and with the help of countries like the United States, to knock down all of the incoming Iranian projectiles. It's important to note here, Iran warned everyone and their mother about the attack. You had at least 48 to 72 hours of notice, enough notice for the U.S.

2:28to preposition assets to help the Israelis shoot down some of these rockets and missiles. Israel, it seems like there was debate within Israel about how to respond and where to respond. And everybody was worried about an escalation. But I was on the Daily Briefing earlier this week with Marco saying, I didn't think there was going to be much of a serious retaliation. And what we got from Israel looks like a couple of drones, according to the Iranians, quote unquote, tried to infiltrate a city called Esfahan and Israeli media is saying they were targeting a radar facility for some of Iran's nuclear research institutions or stations or things like that.

3:04And Iran seems to have made quick work of these drones and says it's not even really recognizing it as an external attack. It has no desire, or at least it is telling everyone it has no desire for any kind of retaliation. So as we're sitting here on Friday afternoon, it sort of seems like we've had the tit for tat and both sides are going to stop. And I think, and we'll get into this. I think in some ways, the most interesting thing in all of this is oil prices are down on the week. Like oil looked at this entire Middle East crisis and just sort of shrugged. And there's some interesting things.

3:35We can get into that later. I'm sure you want to hack into some of the other things with Iran and Israel before we get to market implications. Well, let me ask you this. You used a word when you were having the conversation with Maggie and Marco, you used this idea of telegraphing. Talk a little bit about what you mean by that in terms of why states would, in fact, telegraph an upcoming military action. Well, and that's actually one of the most interesting differences between what Iran did and what Israel did in retaliation. So Iran telegraphed the attack by telling everybody what they were doing.

4:05They announced it. They said, we're going to retaliate. It's going to be measured, though. Please don't start a war against Iran or think that this is some salvo for an invasion of anywhere else or things like this. So they very clearly wanted to manage the escalation. They wanted to express some kind of defiance against what Israel did. But at the same time, they wanted everybody to know, like, we're not going crazy here. We're not going to start attacking all these other targets. Juxtapose that with what Israel did, even in this retaliation. They told the United States at the very last minute, it was a much, much smaller attack than what Iran generated.

4:40And I think there's interesting things to pull from that as well. Israel wanted everyone to know what Iran did. For days in the media cycle, we've been getting these crazy pictures of the missile defense systems at work and Israel railing against Iran in global international institutions and asking for global condemnation and things like that. Whereas Iran's reaction to Israel's retaliation was, eh, that was so weak, we're not even considering that an attack. Everything is back to business here as usual. And you can see there also, Israel wants everybody to know what's going on. And Iran doesn't want anyone to think that there's any weakness there whatsoever.

5:15That's also a very interesting juxtaposition. So that I think also reflects that Iran is the bigger power. It has a different sense of national security and it also has different alliance structures. So you have a difference between Iran telegraphing attack, Israel trying not to telegraph an attack, but also not escalating things by going too far. It's an interesting little dance that, you know, it's not irrational at all. It actually has sort of a strange logic to it if you can put aside all the media headlines that are out there about it. So now the difficult question, what does that suggest about what might happen next?

5:49What are the range of potential outcomes that you see? And how do you see the probability of each of those outcomes stacking up against the other? I think the most likely scenario is that we've seen the worst of this. I think the genie goes back in the bottle for a while. I mean, Israel did what it did. Iran did what it was going to do. And we sort of stopped there. I would put that at maybe 50 % chance of happening. There are still escalatory scenarios on the table, though. The one that scares me that I'd maybe put a 25 or 30 percent chance of at this point is what if Israel decides they need to wrap up the war in the Gaza Strip and that the real existential security threat to Israel in the short term is Hezbollah.

6:24And they feel that they need to do exactly to Hamas – they need to do to Hezbollah exactly what they've done to Hamas since October 7th. And another thing that makes me worried about that scenario is because even though most of the state actors here, it's not in their interest to have a conflict escalate, this Netanyahu government does have an interest in continuing the war. Because the longer the war goes on, the longer Netanyahu does not have to answer for the security failures on October 7th, the longer he doesn't have to face the corruption charges that everybody was talking about before October 7th.

6:56And you're already seeing deep fractures within this unity coalition government in Israel itself. So I'm a little bit worried that maybe Israel is going to take the opportunity to do that. That's not going to be a regional war type scenario. Hezbollah is a major proxy for Iran. Iran will continue to give them weapons and everything else. So it'll be sort of a continuation of the shadow war. But we've seen episodes like this. It's not going to be state on state conflict. The big escalatory scenario, which, you know, maybe 5%, maybe 10%, but which I would be really surprised if it happens is if you continue to get Israeli and Iranian reprisals against each other to the point where maybe Saudi Arabian energy infrastructure is getting involved.

7:35Maybe the U.S. is getting dragged in towards Israel's defense because things are going that direction. Maybe Iran thinks about mining the Straits of Hormuz and blocking oil traffic out of the Persian Gulf and things like that. That scenario, I can't tell you it's impossible, but I think it's extremely unlikely. I think we're probably going to hit pause here and go back to the way things were before, which wasn't that stable. We still got the war in Gaza and Hezbollah firing things at Israel and Israel responding and proxies on the ground in Syria and everything going on in Iraq. It's not like this has always been that stable of a situation.

8:06But I think we go back to that level of proxy war rather than any kind of continuation of state-on-state conflict. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision Daily Briefing. Getting a handle on crypto as an investor has never been more crucial. from the maturation of the market, institutional adoption, and evolving regulation to the Bitcoin halving event, this year is set to be a thrilling one for digital assets. But it's still the wild west with rugs, scams, and some shady players out there. There's a ton of opportunity, but a lot of vulnerability too.

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10:30Let's zoom the camera out here a little bit and talk about the broader geopolitical picture, the context of the Middle East for the strategic interest of the United States. talk a little bit about where we are in terms of the broader global strategic picture. The story for the Middle East from roughly the early 1970s until the shale revolution in the United States was the United States was dependent on the region for energy. And so the United States was willing to defend some of the countries in the region, provide weapons. It was all about balance of power and maintaining supply chains to make sure that energy came out.

11:05The U.S. still has interest in that working in the sense that if you had major blockages in Middle Eastern energy, you could see serious increases in the price of energy or inflation and things like that. But the U.S. doesn't have to import from the Middle East anymore. Also, all of the sort of Cold War reasons that the United States was supporting countries like Israel and like Turkey, they're gone. The Cold War hasn't been around for some time. And Russia is a much smaller version of itself. And Russia's conflict with the United States is not really being fought in the Middle East. It's all about Ukraine and what's happening in Eastern Europe.

11:38So there's a huge shift happening where the countries that are actually most dependent on the Middle East now are these big oil and LNG consuming countries that import from the region. So that's China, that's India, that's Japan, even South Korea imports a lot from this part of the world. So even though we're accustomed to the United States deploying and being so active in this part of the world, it's really these other countries that are more dependent on it. And in some ways, the most important thing that has happened in the Middle East in the last 18 months happened last year. Happened when China brokered an agreement for normalization of ties between Iran and Saudi Arabia.

12:13And where Saudi Arabia basically was okay with Iran consolidating its proxies in Iraq, in Syria, even in Lebanon, and Saudi Arabia saying, okay, we're not going to worry about that so much anymore. We're comfortable with our position. We just want it to be business. We want to do business development. We want people to invest in the Gulf. Like all of this Sunni Shiite stuff doesn't really serve us at all. And ever since that point, with Saudi Arabia and Iran sort of nodded each other's throats, you've had a really different dynamic in the Middle East. And note that Saudi Arabia, I mean, hasn't really said much or done much in response to what Iran is doing to Israel.

12:49And that's aside from the Wall Street Journal reporting yesterday that the Biden White House is still thinking in terms of they're going to get some kind of Middle East peace deal that features a state for the Palestinians and Saudi normalization of ties with Israel. I was joking with Marco actually just yesterday, like, is there a president for dummies handbook out there that says in the last six months of a presidency, you go for an impossible peace deal in the Middle East? I don't know, it seems like every single Democratic president feels like that's something that they have to do. And Biden's trying to do that as well.

13:18The last thing I'll just say here in the country that I think no one has spent enough time talking about, which for me is the most important country in the region, is Turkey. And when I talked to Maggie on Monday, Turkey had been basically completely silent in response to what Iran did. They had actually carried out some of their own attacks in northern Iraq against Kurdish militants in that part of the world. Well, that, of course, didn't get covered at all. But Erdogan came out on Wednesday and said he blamed all of the escalation on Israel, which Israeli strategists should sort of come to a screeching halt at that statement, because that's a country that is much closer to Israel, that can pose much more of a threat to Israel in the long run, blaming everything that happened in the region on Israel and not on Iran, even though I think the Western media is trying to portray this as sort of an Iranian problem.

14:03And then you also have Turkey is apparently, whether the government's behind it or they're just coming from Turkey, there's a freedom flotilla that seems to be gearing up to go from Turkey into the Gaza Strip to break the Israeli blockade there. And if you know your history at all, you know that the last time this happened was the Mavi Marmara incident around 2010, 2011. And it caused a significant break in Israeli-Turkish relations, which really haven't been – they sort of have normalized a little bit, but haven't been, I would say, truly healed since that incident. So I think that's some of what's going on there as well.

14:34The last thing I just want to say here is that, and this is, again, corrective for how the Western media is reporting about this, because a lot of people and a lot of reports are talking about how successful Israel was in defeating these Iranian attacks. I just don't see it that way. When you add up the cost of what Israel had to do to block Iran's attack, it probably cost north of a billion dollars. It required intervention from Sunni Arab states nearby, and it required intervention from the United States that was only there because Iran warned them. If you're sort of taking stock of the Middle East after this conflict, we just saw that Iran is able to impose a much more serious cost on Israeli society, on the cost of missile defense, on Israeli alliances, U.S.

15:17alliances in the region than maybe Israel was to show towards Iran. So if you're sort of net-net at the end of all this, it's the same story as the Houthis in the Red Sea. Iran is showing you U.S. power doesn't mean quite what it used to. Israeli power doesn't mean quite what it used to. Iran can do things that raise the cost of intervention. They can do things, be it their proxies or even themselves, that are going to make things more difficult for Western powers that are accustomed to the region doing what they wanted to do. Let me ask you this. Obviously, this is not an area of expertise for me.

15:49I know about the region, what I read in the Wall Street Journal and Bloomberg and New York Times, like many other people who are not following these stories as closely as you are. Our remit here on Real Vision Daily Briefing is to talk about markets, to talk about what's happening in the world from a financial perspective. Obviously, we know this is difficult with the potential human cost of war, but we need to talk about what's happening in markets because that's our remit here on this show. You mentioned the relatively muted response from oil prices. Talk a little bit about that, its significance, and why you believe you did not see the kind of volatility we've seen as other major escalations in the past in the Middle East.

16:28Yeah, so I mean, I'll put my cards on the table here a little bit at cognitive investments. We've been higher for longer camp for inflation since the beginning of last year. And that call has been pretty good so far. But I can't pat myself on the back too much because I thought towards the end of last year that we would start to see an increase in energy prices. That was part of why I thought inflation was going to be higher and longer. And I sort of have to stop here and say, even though the market has come to, okay, there's not going to be six to eight rate cuts, Maybe there's even going to be an increase.

16:57You know, that was unthinkable even three, four months ago. Even though I think the market has sort of come to where I thought I was going to be when it comes with inflation, energy is not doing what I would have expected in the context of a Middle East crisis. And to me, there's sort of two possibilities there. Number one, the market has become much more geopolitically sophisticated than it was even six months ago. So it's able to read through this shadow boxing between Israel, Iran, and say, yeah, there's really nothing much here. Like, we don't need to worry about this. If Iran's not going to strike Saudi oil infrastructure and they're not going to mind the straight support moves, like who cares that Iran and Israel are taking potshots at each other?

17:33I don't know. I'm not used to the market sort of seeing through that and being that calm and sober about, you know, potential war between states in the Middle East. But the second thing might just be that if energy is not responding the way that I thought that it would, well, maybe the global economy is a little bit weaker than I thought that it was. And maybe the recovery and the inflation is going to start coming down a little bit. So I've sort of stopped in my tracks and said, OK, like I'm getting a signal here that is not quite what I would have expected, because even though I didn't think this was going to be a big deal, I still have a hard time watching oil prices go down in response to a Middle East conflict between two states in the region.

18:08And that's exactly what we've seen happen. So I think for me, it's a moment of sort of humility and sobriety and to say, OK, well, we've got CPI and sort of consensus in markets about Treasury and things like that coalescing in a direction that I thought it was going to go. but then I have energy prices sticking out like a sore thumb and not doing something that they should do when a crisis is underway. So I don't have the answer there for you right now, but I can tell you that what I'll be thinking about this weekend is not the prospects of World War III, but what does that mean? What does it mean during this week that was crazy, that I'm on Real Vision twice, that I'm doing all these interviews, that oil didn't just sort of stay stagnant, like actually fell a little bit.

18:43That tells me that maybe I need to rethink where I'm at with some of my fundamentals going forward into Q2 and Q3. Let me ask you this. As we talk a little bit about your base case for what's happening with inflation and what's happening with, therefore, the interest rates here in the United States and elsewhere, what are your thoughts about that? Do you have a new base case? You said it's trended in the direction that you predicted or that you believed it would be going into. Tell us a little bit more about what your new expectations are going forward? Yeah. So my longer macro expectation sort of over a period of years is that you're not going to have inflation going up and to the right.

19:21And you're not even going to have it going down either. I think generations of American investors, global investors have gotten used to, okay, prices always increase and inflation or excuse me, or interest rates always go down and stocks always go up. And I think what we're looking at when you look at inflation, I think we're looking at volatility. So I think we're going to have periods of elevation. I think we're going to have periods of deceleration. We're going to ping pong back and forth between them. And for activist investors, this is good news because you can no longer just sort of set a passive clock on where things are going.

19:52You have to really be in tune with how different things, whether it's trade developments or currency developments or other macro developments or geopolitical developments, are going to move things here. So that, I think, is the trend we're in, at least for the end of the decade. I expect a lot of volatility here. I don't think you'll just be able to, like I said this with Maggie earlier in the week, if you look at inflation data or CPI data in the United States from 1955 until 2009, every single month, inflation went up, CPI went up. And there was a little blip around the 2008 financial crisis.

20:24So you get those little blips in 2009, 2010. And then it still goes up sort of from there. I think we're going to see a lot of back and forth when it comes to inflation. And the question is right now, where are we in that volatility cycle. I had very high conviction six months ago that I thought things were going to go up. And I thought sort of from a contrarian perspective that people were underestimating where things were going to go from there. Right now in this moment, April 19th, I'm very uncertain. Sort of I checked off the box. I had high conviction on that view for the last six months.

20:52I don't have high conviction on where we go from here. And one of the reasons I don't have high conviction and one of the reasons I think it's hard to generate that conviction is because the results of the U.S. presidential election are going to matter a big deal in where that goes. And that's impossible to predict. Polls have been wrong for a long time. And even if it was just polls, I wouldn't trust those that far out. So I think we're sort of in a holding pattern here. And I'm sort of happy to say, OK, like I don't have the high conviction view anymore. Let's see where we go. Let's see where things go between the United States and China, which look like they're going to have a little mini trade war again as Biden tries to buttress his protectionist credentials going into the election.

21:32And let's see what happens, what the Fed actually does. Does it actually cut? Does it feel like it has to completely change its mind on where it was going and reset? These are questions that I think we need to answer now. So the answer to your question is I don't have a high conviction view right now. I did for the last six months, but we've sort of gotten to where I thought we were going to go. And I'm staring at November, and I just see a lot of uncertainty and volatility from here until then. We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision Daily Briefing.

22:05Well, let me ask you this. We don't do partisan politics on this show, but talk a little bit about what you see the range of outcomes being in this presidential election, specifically with regard to its impact on financial markets. Trump and Biden just have articulated very different ways of accomplishing goals that are roughly similar. So they are both protectionist. They are both America first. They are both neither one of them has anything approaching fiscal discipline. So they have some similarities in common, but how they get from point A to point B is very different. So Trump wants to use tariffs.

22:39Trump wants to use a very blunt instrument, whereas Biden has been much more surgical. He didn't get rid of any of Trump's tariffs, but he didn't really put any new ones on. He wasn't going after China in sort of a blanket way. And there's a big difference between trying to do things surgically and trying to do things with the blunt instrument. Biden's approach also means more incentives, more things like the Inflation Reduction Act, trying to sort of bring things not just to the United States but to U.S. allies and partners, whereas Trump represents much more of an allies and partners isn't good enough.