How to trade war

Iran’s war shakes up the markets; the biggest enemy for investors may not be geopolitics itself, but the various “miracle cures” being hawked opportunistically by the financial industry—and the urge to chase overheated assets.

As the U.S.-Iran war continues to intensify and the outlook remains hard to predict, traditional “safe-haven and beneficiary” assets in the U.S. market—defense, energy, gold, and others—have surged sharply, with valuations generally at historical highs. At the same time, the financial industry is accelerating the rollout of themed products, claiming they can help investors sidestep war and inflation risks or profit from them.

In a report citing professionals, The Wall Street Journal warns that, for the most part, market prices have already fully baked in the obvious war narrative. The cost of chasing popular assets is far higher than it was before the war. At the same time, the direction of the war is hard for even the governments of the countries directly involved to predict— any major investment decisions based on geopolitical forecasts carry significant risks.

Under the current circumstances, investors’ defenses should point in two directions at once—guarding against bad news that the war could bring, as well as investment opportunities that the financial industry might try to sell.

War creates investment hype; the financial industry seizes the moment to market it

Once the war starts, investors often become the main targets of intense financial marketing. A wide range of products are packaged as “insurance” against war and inflation, or “tools” to profit from them—funds, specific assets, sector ETFs, AI-driven investment recommendations, proprietary trading signals, and algorithms have emerged, accompanied by a hefty price tag.

These marketing narratives have their own internal logic: war requires weapons and equipment; oil supply is constrained; panic and uncertainty boost demand for gold. These observations seem straightforward enough to be hard to refute. However, the market has already fully priced in the obvious part.

California-based IFA Institutional investment advisor Mark Higgins, author of The Investment History of American Finance, offers a pointed counterquestion: “When the government itself doesn’t know what will happen next, why are you saying this?” Those words are enough to end any attempt to persuade you into taking aggressive action on the grounds of geopolitical predictions.

Valuations of热门 assets are soaring; the cost of protection has risen sharply

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

According to FactSet data, major defense and aerospace stocks such as Lockheed Martin, Northrop Grumman, and L3Harris Technologies have all risen more than 24% since the start of the year. The price-to-earnings ratio (past 12 months) of iShares U.S. Aerospace and Defense ETF holdings is already 41.5x, representing a premium of more than 50% versus the overall stock market; valuations for many individual stocks are nearing historical highs.

In the energy sector, crude oil prices have risen 67% cumulatively this year. According to FactSet, energy stock ETFs have attracted more than $7.0 billion in new inflows this year alone, with $2.3 billion pouring in just since early March. The price-to-earnings ratio of holdings in the State Street Select Energy Sector ETF rose from the 8x to 10x range in 2022–2023 to 22.4x this week.

Gold has gained 51% over the past year. Although it has pulled back 12% this month, it still remains near historical highs. Gold’s retreat may suggest that “panic trades” are partially unwinding—since the war began on March 2, the first trading day, defense and aerospace ETFs have fallen by at least 5% cumulatively.

As the market proverb goes: when the sun is shining, you don’t buy an umbrella; now that you’re seeking shelter, the cost will be very high.

The war’s course is hard to predict; geopolitical bets are extremely risky

The direction of this war has repeatedly gone beyond expectations on all sides. The White House initially expected its “short, decisive operation” to quickly topple the Iranian government, but it has since stretched on for weeks. For now, the situation on the ground is far different from early assessments at the start of the war.

In an environment where uncertainty is so high, making major asset-allocation adjustments based on anyone’s geopolitical predictions is, in essence, a gamble with questionable odds of winning. Even the governments of the United States, Iran, and the relevant countries themselves have been caught off guard multiple times by sudden turning points in the fighting.

The same historical pattern is also worth watching out for: unexpected events and negative news often prompt investors to rush into strategies that are entirely different—rapid trading, timing entry and exit, chasing extremely high dividends, and so on. These tactics claim they can reduce risk or improve returns, but in highly uncertain markets, the cost of aggressive actions is often far greater than the benefits.

Inflation hedging has its basis, but avoid big moves that are hard to reverse

If you’re worried that the war could push up inflation, you might consider inflation-protection tools issued by the U.S. Treasury, rather than blindly chasing commodities assets that have already been pumped up.

U.S. Series I Savings Bonds (Series I Savings Bonds) are anti-inflation savings bonds issued by the U.S. Treasury. The current yield is 4.03%; this six-month rate will reset on April 30, but they can only be purchased directly through the Treasury’s official website.

Treasury Inflation-Protected Securities (TIPS), meanwhile, can be obtained by purchasing directly from the government, through a brokerage account, or by bundling them into mutual funds and ETFs. They currently still offer real returns about 1% to 2% higher than the official inflation rate.

A competent financial adviser at this moment should be discouraging clients from taking aggressive action, not fanning the flames. Selling losing assets to offset taxable gains may be reasonable, but making a big rebalance to cope with panic that may never even materialize is not worth it.

Mark Higgins advises investors to avoid major, rushed adjustments to their investment portfolios. No matter how the war evolves, any move that is difficult to unwind at low cost should be off-limits.