How to trade war

The Iran war roils the market, but the greatest enemy for investors may not be geopolitical risks themselves, but rather the various “magic cures” sold by the financial industry in such times, and the impulse to chase overheated assets.

As the US-Iran war continues to escalate and its future remains unpredictable, traditional “safe haven and beneficiary” assets like US defense, energy, and gold stocks have already surged, with valuations typically at historical highs. At the same time, the financial industry is accelerating the launch of themed products, claiming they can help investors avoid war and inflation risks or profit from them.

The Wall Street Journal cites professionals warning that current market prices have already largely priced in the obvious war logic, and the cost of buying into hot assets is much higher than before the war. Meanwhile, even the governments of the involved countries cannot grasp the trajectory of the war, so any major investment decision based on geopolitical forecasts carries massive risks.

Under current circumstances, investors need to defend themselves on two fronts—against the potential negative news from the war, and against investment opportunities that may be sold by the financial industry.

War generates investment gimmicks, and the financial industry seizes the opportunity for marketing

Once war breaks out, investors often become the focus of concentrated financial marketing bombardment. Various products are packaged as “insurance” against war and inflation, or as “tools” to profit from them—funds, specific assets, sector ETFs, AI-driven investment advice, proprietary trading signals and algorithms are rolled out, often with hefty fees attached.

These marketing narratives have their internal logic: war requires weapons and equipment, oil supplies are constrained, panic and uncertainty drive up gold demand. These observations seem so obvious as to be irrefutable. However, the market has already fully priced in the obvious parts.

Mark Higgins, Institutional Investment Advisor at Irvine, California, and author of “Investment History of American Finance,” provides an effective retort: “When even the government doesn’t know what’s coming next, why would you say you do?” This serves to put an end to any persuasion attempts using geopolitical forecasts to urge you into aggressive operations.

High valuations in popular assets, the cost of protection has risen sharply

A large amount of capital has already completed its allocations, leaving little margin of safety for latecomers.

According to FactSet data, major defense and aerospace stocks like Lockheed Martin, Northrop Grumman, and L3Harris Technologies have all risen over 24% so far this year. The price-to-earnings ratio (past 12 months) of iShares US Aerospace & Defense ETF has reached 41.5x, a premium of over 50% compared to the overall stock market, with many individual stocks approaching historic valuation highs.

In the energy sector, oil prices have risen 67% so far this year. According to FactSet, energy stock ETFs attracted over $7 billion in net inflows this year, with $2.3 billion entering just since early March. The State Street Energy Select Sector ETF’s price-to-earnings ratio climbed from the 8-10x range in 2022-2023 to 22.4x this week.

Gold has risen 51% over the past year; though it dropped 12% this month, it remains near historic highs. The ebb in gold may signal that “panic trading” is partially subsiding—since the first trading day of the war on March 2, defense and aerospace ETFs have fallen at least 5% cumulatively.

As the saying goes: If you didn’t buy an umbrella when the sun was shining, seeking shelter now will come at a steep price.

War is hard to predict, geopolitical bets carry extreme risk

The trajectory of this war has repeatedly exceeded all expectations. The White House originally anticipated a “short campaign” that would quickly topple the Iranian government, but the conflict has dragged on for weeks. The situation now bears little resemblance to the initial forecasts.

In a climate of such high uncertainty, making major asset allocation adjustments based on anyone’s geopolitical predictions is fundamentally a gamble with dubious odds. Even the governments of the US, Iran, and related countries have been caught off guard multiple times by sudden twists in the war.

Historical patterns also merit caution: sudden events and negative news often push investors to hastily shift strategies—rapid trading, market timing, chasing ultra-high dividends… These tactics claim to reduce risk or boost returns, but in highly uncertain market environments, the costs of aggressive moves often far outweigh the gains.

Inflation hedging is reasonable, but major irreversible moves should be avoided

If worried that war may drive up inflation, consider US Treasury-issued inflation-protection tools rather than blindly chasing already inflated commodities.

US I Bonds (Series I Savings Bonds), issued by the US Treasury, are inflation-protected savings bonds currently yielding 4.03%, with the semiannual rate to reset on April 30, but these can only be purchased directly from the Treasury website.

Treasury Inflation-Protected Securities (TIPS) can be acquired directly from the government, through brokerage accounts, or bundled into mutual funds and ETFs, currently offering real returns about 1% to 2% above the official inflation rate.

A competent financial advisor should now be persuading clients not to take aggressive action, rather than fueling it. Selling loss-making assets to offset taxable gains may be reasonable, but drastically reallocating a portfolio to address panic that may never materialize is not worth it.

Mark Higgins advises investors to avoid major and hasty portfolio shifts. No matter how the war develops, any move that cannot be unwound at low cost should be considered off-limits.

Risk Warning and DisclaimerThe market carries risks; invest with caution. This article does not constitute personal investment advice, nor does it take into account the unique investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article fit their specific circumstances. Investments made based on this article are at your own risk.