Rudi’s View: TACO Time?

Rudi's View | 10:00 AM

Are we there yet? From here on onward, that question is on traders and fund managers' mind.

By Rudi Filapek-Vandyck, Editor

It has taken exactly one week since Tehran became the target of Israeli and US bombs. While Iran's leadership was swiftly decapitated on day one, with Supreme Leader Ayatollah Ali Khamenei killed alongside multiple senior regime and security officials, the regime's vicious retaliation has surprised by causing significant damage to US assets throughout the region, as well as to the growth outlook for the global economy through a spike in energy prices.

The Strait of Hormuz --bottleneck for roughly 20% of the world's oil transports-- is effectively closed, irrespective of US' intentions to the contrary, and the longer this remains the case, the greater the damage to economies and financial markets, the US included.

At first, markets focused on the potential for higher inflation, but in today's world dynamics change quickly. Within the space of one week markets' worry has shifted to global growth.

That shift in momentum explains why shares in BHP Group ((BHP)) have swiftly changed course from rallying towards $60 to now trading around $50 on Monday, and dragging the local index with it.

The world has changed dramatically over the decades past, but the last time the price of oil doubled within a relatively short time --in mid-2008-- the global economy still faced a recession, even though other factors contributed as well (think the demise of Lehman Bros).

In December, only four months ago, WTI crude oil traded around US$55/bbl. On Monday, futures rallied beyond US$100/bbl. It's not difficult to see why stunted growth and oil-vulnerability are now in focus.

Put on your worst case scenario hat and the world is staring at a come-back of the 1970s --low growth in combination with high inflation-- a surefire recipe for disaster.

Not making things any easier is asset prices in 2026 are substantially higher-priced than back then.

Offsetting all of the above is today's US President might well be the most sensitive to adverse developments in financial markets.

Up until the weekend, markets reflected confidence this outbreak of hostilities would not last long, and by doing so they were granting Trump & Co the opportunity to do whatever, whenever, however, and for as long as it takes.

That dynamic has changed now, as it is intended by Tehran's strategy. So when's Trump ready to TACO and call it "the greatest victory the world has ever seen" and pull up stumps?

(To those not familiar with the acronym, TACO refers to 'Trump Always Chickens Out' in reference to his art of the deal strategy by first declaring the worst proposition, and then scaling back to something more palatable).

Or is this really a diversion tactic over the Epstein files or an even more nefarious intent regarding the upcoming midterm elections?

Most investors not sitting into cash and/or energy-leveraged assets will be keeping their fingers crossed this is not the one time Trump decides to ignore the pressure building from financial markets (and from allies the world around).

Lessons From History

Plenty of historical precedents are available to suggest the world can deal with a temporary disruption to oil supply and a spike in energy prices.

Strategists at UBS last week published an overview reaching all the way back to the Yom Kippur war in late 1973 up until Israel's 12 day war with Iran in June last year. With exception of only four examples, equity markets were trading higher twelve months later.

Of those four examples, three involved economic recessions including Yom Kippur, 9-11, and the Saudi oil drone attack in September 2019 (covid followed next) while the Arab Spring in 2011 preceded Europe's Grexit crisis.

The first gulf war in August 1990 kept equities down in double digits for the following six months.

History does show such outcomes are more exception than rule. When relying on less negative outcomes, the rule of thumb seems to be that temporary oil supply disruptions are remedied within the space of circa four months.

Financial markets too tend to normalise within such period.

One key problem at this stage is there are no signals or indications about an imminent victory or cease-fire. As analysts at RBC Capital put it:

"Given the course of events, it is unclear whether the administration built an exit on its way into this latest military entanglement."

History does suggest whenever human decision-makers and financial markets move in diametrically opposed direction, it's usually the former who, eventually, is forced to change.

When Trump suggested the idea of taking Greenland by military force, it was suggested he abandoned that idea because financial markets were signalling they didn't approve.

But how much damage/pressure needs to occur before "the greatest peace-maker of all time" gets the message and responds accordingly?