How Do You Say TACO in Farsi?

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

 

 

The latest signals of each model are as follows:

The TALO-TACO Cycle
Both the Pentagon and Israel have set expectations for a multi-week military campaign against Iran. I believe political pressures will shorten the war in a way that’s beyond the control of military planners. Rising financial market stress, rising bond yields, and surging equity and bond option risk will force Trump to shift from TALO (Trump Always Lashes Out) to TACO (Trump Always Chickens Out).
 

 

Here’s why.
 

 

Iranian Strategy
While U.S. objectives in this war are less clear, the Iranian regime’s objective in this war is clear. It’s an existential fight for survival. The strategy is to impose high enough costs to the coalition that they’ll sue for peace.

• Raise the global price of energy.
• Raise costs for Gulf states that they will pressure the U.S. to seek an exit.

Iran has declared the Straits of Hormuz to be closed. But the Strait isn’t a canal, and it must be interdicted. Iranians have fired missiles at ships and tankers in the past few days in order to retard tanker traffic. As well, Iran has attacked energy infrastructure and civilian targets in the Gulf to raise costs for her neighbours.
 

 

This has raised alarm among Iran’s neighbours. For instance, Dubai has cultivated a reputation of being a Monaco-on-the-Gulf, but missiles and drones raining from the skies is bad for business. As airspace restrictions intensify, there are reports of ex-pats stampeding for the exit by paying up to $350,000 for a single seat on a private jet to leave the region, and with no guarantees.

Financial costs are imposed on Gulf states to intercept Iranian missiles and drones. In the first two days of the war, Iran reportedly sent 165 ballistic missiles (at $1–$2 million apiece), 541 Shaded drones (about $50,000) and two cruise missiles ($1.5 million each) at the United Arab Emirates. The UAE interception rate was an impressive 92%. But the costs were extraordinary. Interception doctrine calls for two interceptors per target, but each Patriot missile costs $4 million. THAAD (high altitude defense) missiles cost even more. The math for Shaded drones is particularly challenging when each drone costs about $50,000. Bloomberg reported that the UAE and Qatar could run out of interceptors in less than a week at the current pace, and they are pressuring the U.S. to find an off-ramp.

To be sure, U.S. theatre missile defense (TMD) doctrine does not call for an impenetrable shield for an indefinite period. Instead, it’s intended to buy time for your friendly forces to neutralize the enemy’s launch capabilities. The good news is the rate of Iranian missile fire has fallen dramatically. The bad news is Iran has switched to attacks with cheaply made Shaded drones, which coalition forces have no defense for. Ukraine faced this problem and it has produced drone interceptors, which President Zelenskyy has offered to share with the U.S. and Gulf states.

 

The attacks against Gulf infrastructure have led to QatarEnergy declaring force majeure by suspending the production of LNG, along with other downstream products like urea, polymers, methanol and aluminum. By closing the Straits of Hormuz and forcing the suspension of LNG shipments, Iranian actions took about 20% of global oil and natural gas shipments offline. As well, the suspension of urea shipment idled 10% of global fertilizer capacity. Adam Tooze observed that the curtailment of urea production coincides with the spring planting season, which will impact agriculture and food prices for the rest of the year. The transportation bottleneck at the Strait works both ways, the Gulf states import most of their food from overseas and a prolonged closure would raise food insecurity issues for the region.

These are financial and human costs that the world has to bear. It’s an open question how long the war persists and how long these embargoes last. So far, the Iranians have held their fire and the real Achilles Heel of the Gulf states, de-salination plants. The Economist reported that “Kuwait derives 90% of its drinking water from desalination, Oman 86%, Saudi Arabia 70% and the UAE 42%. In leaked cables published in 2009 American diplomats estimated that a successful attack on Saudi Arabia’s Jubail plant, which then provided Riyadh with 90% of its water supply, would force the kingdom to evacuate its capital within a week. Saudi Arabia has built more capacity since then, but desalination plants are highly vulnerable to missiles.”

In response, President Trump declared that the U.S. Navy would start to escort tankers through the Straits of Hormuz, and the Development Finance Corporation (DFC) would provide a maritime insurance backstop.

While these steps are positive developments for greater stability in the region, they will take time to implement and could be prohibitively expensive. Typical escort services require small frigates, not aircraft carriers, and the U.S. doesn’t have many frigates in the region. Escorting every single tanker and container ship will create a bottleneck, and providing strong protection requires air cover. Coalition navies had enough trouble suppressing Houthi interdiction in the Red Sea, and this latest mandate will require a surge in military resources that the U.S. may not be able to sustain over time. Paradoxically, China may succeed where the U.S. faces a Herculean task. Beijing announced that PLAN ships will escort Chinese tankers through the Strait, which is a limited mission that may succeed.
 

 

In addition, the DFC is a development finance agency with no expertise and experience in underwriting maritime war risk insurance. No actuarial models for Gulf transit, or re-insurance relationships to support this venture or claims handling infrastructure. You see the problem.

In summary, the Iranian regime is racing against time. Can it cause enough pain for the coalition and Gulf state neighbours before Iranian military capabilities are wiped out? What’s the next step on the escalation ladder?
 

 

Trump’s Electoral Challenges
While the Iranian leadership’s challenges in the war are military, Trump’s challenges are mainly political and economic. He is facing mid-term elections in November. His approval ratings are extremely weak, even compared to Trump 1.0.
 

 

The Republicans are expected to lose control of the House. The betting odds for Republican control of the Senate, while still favourable, are fading.
 

 

Trump is being pressured by his MAGA base of supporters over his “no foreign wars” pledge. Former Trump ally and America First advocate Marjorie Taylor Greene posted on X/Twitter a diatribe against his “No More Foreign Wars, No More Regime Change” pledge that’s emblematic of the feeling of betrayal from his support base. While polls indicate that support from his political base hasn’t suffer much erosion, the Republicans are at risk of losing control of the Senate if too many supporters stay home in November.
 

It doesn’t help that the goals for going to war keep changing. The reason was an imminent Iranian capability to produce nuclear warheads, which he claimed to have obliterated in June. It was freedom for the Iranian people, which was abandoned as a talking point. He characterized regime change as “that would be the best thing that could happen”, but that pledge was walked back by the Pentagon.

It emerged that Israel threatened to bomb Iranian missile sites, with or without U.S. involvement. Trump took the decision after an intelligence coup found that Iranian Supreme Leader Ayatollah Khamenei would be meeting with senior leaders of the government on Saturday morning. The State Department confirmed the reasoning in a X/Twitter post with a quote from Secretary Rubio: “There was absolutely an imminent threat. We knew that if Iran was attacked, even by someone else, they would immediately come after us and we were NOT going to sit there and absorb a blow before we responded.”

Allowing an ally, no matter how close, to dictate American foreign policy to go to war was not going to sit well with the public, especially with Trump’s MAGA “no more wars” supporters.

After some public pressure, the White House put out a statement outlining its war objectives. While the first two points are within the control of the U.S. military, the last two imply statements of intent by the Iranian government. Otherwise, how can anyone be assured that support for regional proxies or nuclear enrichment won’t be restarted. The statement amounts to a desire for regime change.
 

 

Trump was also undecided on whether the U.S. would put boots on the ground. Air wars have never been able to achieve the objective of regime change in the past. Reports emerged that the CIA had been funneling arms to Kurdish rebels before the attack, and a Kurdish army is massing on the edge of Iranian territory.

Kurds are mostly Sunni, and Iranians are mostly Shia. This attempt to support the Kurds in the establishment of a Kurdish homeland would ignite a regional conflagration. Many Iranian opponents of the regime would rally around the flag and support the regime against the foreign invader. It is likely to draw in neighbouring Turkey in a conflict against the Kurds. It’s a recipe for Libya 2.0.

The Financial Times reported that the sovereign wealth funds of the big four Gulf states, Saudi Arabia, the United Arab Emirates, Kuwait and Qatar, have begun internal reviews of their investments in order to offset the financial stress of the war. Any hints of investment liquidation programs could put considerable downward pressure on asset prices and encourage a TACO pivot in U.S. policy.
 

 

The Affordability Challenge
A second political challenge that Trump faces is economic. He won the last election by painting Joe Biden as an out-of-touch leader who was insensitive to the problem of growing unaffordability of everyday life. Instead, Trump committed the same error as Biden at the last State of the Union address by hailing his own economic progress: “Our nation is back: bigger, better, richer and stronger than ever before.”

The war has spiked oil prices and gasoline, which is the most visible price to consumers. According to Gas Buddy, gas prices averaged $2.30 during Trump’s first term. The latest reading is $3.32, which is below the psychologically important $3.50/gallon level that would raise political heat. The NY Times reported: “A Reuters/Ipsos poll found that shortly after the strikes, about a quarter of U.S. adults supported the military campaign against Iran. That poll found 45% of American adults said their support would weaken if the U.S. saw higher gas or oil prices.”
 

 

 

Time to TACO
Trump is also facing external financial pressures to reverse course. The Financial Times reported that the sovereign wealth funds of the big four Gulf states, Saudi Arabia, the United Arab Emirates, Kuwait and Qatar, have begun internal reviews of their investments in order to offset the financial stress of the war. Any hints of investment liquidation programs could put considerable downward pressure on asset prices and encourage a TACO pivot in U.S. policy.

In the face of these multi-dimensional pressures, I expect a TACO pivot in the near future in order to alleviate some of the political pressure. My base case is an offer to negotiate, and the ultimate settlement will be some variant of the now abandoned JCPOA that restricts Iranian capability of nuclear weapon development. It would leave the Iranian regime intact, and a geopolitically more precarious Middle East. But it’s an exit ramp for each side to declare victory and go home.

I published a note on Wednesday calling for a tactical short-term bottom (see A Washout Bottom?). Two of the components of our S&P 500 Bottom Spotting Model flashed buy signals. Tuesday was an unusual day inasmuch as stock, bond and gold prices all fell together. When asset correlation converges to 1, it’s often a capitulative sign of a risk manager-induced forced liquidation event that often occurs near market bottoms. The model triggered a second buy signal Friday when three of the five components triggered buy signals.
 

 

Last Friday’s downdraft brought the market to an oversold condition. The Zweig Breadth Thrust Indicator is within a hair of an oversold reading, and the NYSE McClellan Oscillator (NYMO, bottom panel) has reached levels consistent with short-term bottoms. While oversold markets can become even more oversold, stock prices are poised for a bounce, if history is any guide.
 

 

U.S. equities have the relative safe haven during the war, as the rest of the world has higher sensitivities to energy prices. A TACO pivot should see non-U.S. stocks turn around and U.S. stocks lag. Speculative traders can consider markets that have skidded the most, such as the South Korean KOSPI which has suffered consecutive daily double-digit declines since the onset of the war.
 

 

Traders who seek to participate in the upside of any market bounce within the U.S. cab consider an allocation to small-cap stocks. The accompanying chart shows that while the small-cap S&P 600 fell, the S&P 600 Advance-Decline Line rose and formed a bullish positive divergence.
 

 

Needless to say, the caveat to my bullish scenario depends on stabilization and retreat in energy prices. Much depends on the outcome of the war.

In conclusion, both the Iranian regime and the Trump Administration face different pressures to bring the war to a conclusion. In particular, Trump is under political pressure from his support base for his “no wars” pledge. Rising energy prices put upward pressure on inflation, which threatens the “affordability” promise that he campaigned on. I believe that these pressures will force him to a TACO (Trump Always Chickens Out) pivot in the near future.