Despite temporary “ceasefires”, the Middle East conflict is a slow motion “train wreck” that always has the potential, in the months and years ahead, to surprise and blow up into something much bigger. Nobody really knows how the “tea leaves” will eventually play out. Likewise, a mere four weeks ago, no one was boldly predicting the fall of the 50+ year Assad family regime in Syria.

Iran (its nuclear program and any Israeli/U.S. response) is a key element to this Mid East chess board and any long-term peaceful resolution. As a result of recent events, the Iranian nuclear project is exposed like never before to an Israeli attack. Moreover, an important question to ask: will Iran now make a “mad-dash” to complete a nuclear weapon, thereby setting off a chain of future military reactions?

Critics from the press, and outside observers, correctly point out that Prime Minister Netanyahu has refused to fully reveal what comes next. He’s offered no “grand” political or diplomatic solution for the “day after.” The only clear goals seem to be that Israel and the West will not tolerate Hamas as a governing body in Gaza.

There will be no easy solution to a lasting peace in Gaza. Whether it be a partial Israeli occupation, a Palestinian Authority takeover, an Arab peacekeeping force, or some yet to be figured out solution. Israel is in no rush to show its “day after” hand because there are no easy answers, but many potential pitfalls and traps for the naïve.

The historical dilemma for Israel is easy to understand. As one astute journalist recently stated, “Israel can defeat its enemies… but it can’t conquer its way to peace.” And on the other side, you need a Palestinian population that demands “land for peace” from its leadership, rather than providing majority support for radical Islamist parties or pipe dreams of “from the river to the sea”.

For Israel, turning its military wins into political/strategic gains has always been the unattainable part. Simply stated, Israel is not a superpower and thus has neither the resources, manpower or will to rebuild and win the hearts & minds of 2 million Gazans, let alone the country of Lebanon.

Israel’s key military asset is simple: “super deterrence”. That means… leave the resourceful “bumble bee” alone, and it goes about its daily routine peacefully. But interrupt & attack that same busy bee from its daily tasks, and the consequences can be fatal/catastrophic for the aggressor. This has been the case in Gaza over the past year, and now in Lebanon.

Unfortunately, stinging “deterrence” alone will not bring long term lasting peace to the region. At best it will only bring extended periods of shaky calm.

As many before us have already stated, in the absence of a mutually agreed political agreement, there cannot be a durable solution on the Palestinian/Israeli conflict. For that to happen, it still takes “two to tango”. Meaning, from the two main protagonists.

In our humble opinion, what would be a clear signal that a durable peace could be on the horizon? When a Palestinian leader emerges along the lines of the late Egyptian president Anwar Sadat. Sadat was the first Arab leader (post 1948) who made the bold decision, and historic step in November 1977 to travel to Israel seeking peace.

It took four years after the end of the October 1973 Yom Kippur war for Sadat (having regained Egyptian honour on the battlefield) to embark on this historic journey to Jerusalem. A similar “Sadat” moment in history would give us a positive reason for hope. We will just have to wait and see what happens by 2029! Nothing happens overnight in this region.

As for the markets – the Buffet Valuation Indicator (a market valuation measure) is signaling potential danger as it surpasses levels last seen during the dot-com bubble and the 2007-2009 Great Financial Crisis.

This indicator, attributed to Warren Buffet, compares the total market capitalization of stocks (Wilshire 5000 total market index) to the gross domestic product (GDP) to determine if equities are undervalued or overvalued.

While this indicator ratio is far from perfect on timing, it can be, according to Buffet “a very strong warning signal”. The current Wilshire 5000-to-GDP ratio stands at approximately 208%, surpassing the 140% ratio at the height of the 2000 internet stock frenzy.

In conclusion, from our years of investing experience, overvalued stock markets by themselves don’t cause bear markets. Rather rising interest rates and/or a surprise shock to the financial system are often the necessary ingredients to eventually derail bull markets. Normal market corrections in the months ahead can be expected, it’s all part of the game.

And finally, today’s stock market valuations speak volumes about more subdued future market returns.
 

Respectfully yours,

Benjamin D. Horwood

Portfolio Manager
December 12, 2024