War and Probability

The US has bombed Iran. Looking at the potential events as they are about to unfold strictly through the lens of the most widely followed global stock market index, we should manage our expectations as follows:

Path number one, Iran does nothing (or very little). We come to some sort of agreement, and whatever happens in this part of the Middle East disappears to page five of our news feed, just below what the price of eggs is doing. Likely S&P500 reaction?  Up 10%, probability 50%.

Path number two, Iran responds in a long, drawn-out war of attrition, with the occasional rocket and drone exchange, but no ground troops or tanks, lots of proxy wars, and a significant impact on global supply chains. Likely market reaction? Down 20%, not immediately, but seemingly never ending, probability 25%.

Path number three, whatever is happening in the world, this just becomes another step in a process that could bring about a completely new geopolitical constellation, with an outcome we cannot possibly fathom at this stage. Likely movement in the index? Flat, because you know, we don’t know anything yet, probability 24%.

Path number four, this is the beginning of the end. We are going to see nuclear weapons being used on cities, and many people will die, mostly from the effects of climate change, given that more explosives will have been detonated than in World Wars One and Two combined. Likely change in the value of the market? Down 60%, probability 1%. 

Putting it all together and calculating a weighted average as such, means the S&P 500 should be down around 0.6% today, which incidentally and not entirely surprising, is where the index is trading in the futures market this morning.