The "Trump always cries out" strategy of buying down-market stocks, assuming that the U.S. president will eventually back off his more extreme policy, has been profitable for most investors. But the Iran war could change that.

The U.S. and Israeli attack on Iran, which took place on February 28, has sparked a war in the Middle East. It triggered the 'biggest energy crisis since the 1970s' and a record level of volatility for oil and gas.

U.S. stocks have been relatively calm so far. This is likely due to the assumption, that Trump may pull back, if needed. Since February 28, European and Asian stocks, as well as emerging markets have fallen 4-7%. The S&P is down by 1%, and the Nasdaq has gained 0.5%.

This conflict could be a "TACO", too far.

Even if Trump declared an end to the conflict tomorrow, there is damage that has already been done. It cannot be reversed quickly, not even by him.

Truth Social posts or the stroke of the pen cannot fix the stifled oil production, the bombed out infrastructure, or the disruption of global energy flow. It could take years to get everything back to the pre-war condition.

Even after the hostilities end, it is unlikely that the costs of shipping out of Middle East or insuring ships in the region will return to "normal".

Eswar Prasad is a professor of economics and political science at Cornell University. He says that while the global financial markets were able to shrug off the volatility caused by Trump’s unpredictable policies, the geopolitical and economic ramifications from the Iran War are likely to be far more significant.

It is the first instance that the Strait of Hormuz, the vital waterway where 20% of daily energy consumption in the world passes through, has been effectively closed. The Strait of Hormuz has never been closed before, not even during the Iran-Iraq War, the Gulf War or the Iraq War.

Even in the 'optimistic scenario' of the market, whereby the U.S. ends its attacks quickly, there would still be a lot of instability beyond Trump's reach. Who knows how long this could continue, or how bad things could get.

THE 'TACO' PLAYBOOK

Trump's geopolitical and economic playbook for his second term was to push accepted norms and rules to the breaking point, or beyond. Then he would wait to see what the market reaction would be. Investors who barely blink are given the green light to continue, or even accelerate. Trump will step back from the edge if markets crash.

Since Trump returned to his White House office 14 months ago, the president has unraveled America’s 80-year alliance to Europe, endangered the existence of NATO and threatened to annex Greenland, Canada, ousted Venezuela’s President, and threatened to fire Federal Reserve chair Jerome Powell.

Markets reacted to these events in a variety of ways, forcing Trump's rhetoric to be toned down. This led to the "TACO trade."

The risk premiums have been relatively stable despite the geopolitical turmoil of the past year. Volatility has also remained low.

The "Liberation Day", or "TACO", tariffs of last April were the biggest of all. Trump backtracked on his most punitive tariffs after trillions of dollars were erased from the U.S. stock markets in just a few days.

The conflict today in the Middle East, however, is a different one and could be more risky than any in recent years. Investors looking for historical precedents may find the 1973-74 oil shock useful in determining its economic impact.

The oil prices will not quadruple as they did in the 1980s, especially since the U.S. has become the largest energy exporter and producer. Remember that although the OPEC embargo lasted for only six months, inflation caused by it haunted U.S., and other industrialized countries, throughout the remainder of the decade, and into the 1980s.

Stagflation could be triggered by a persistent rise in energy prices or disruptions to global supply chains. Investors might now begin to wonder?whether Trump will be able to resolve this crisis, even if "he chickens out."

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(source: Reuters)