This Means War!

The heavy attack on Israel this weekend by the Palestinian militant group Hamas has shocked the world. So far, about 1,500 people are confirmed dead. That number will only grow.

We don’t have many facts at this point, but it appears to be a massive intelligence failure by Israel. That in itself is shocking because Israeli intelligence is generally excellent.

It also suggests that Hamas is capable of highly sophisticated intelligence operations of its own, which allowed it to conceal the attacks, which were highly coordinated. The attacks came from air, land and sea.

Meanwhile, Israel has declared war on Hamas. What motivated the attack, which some people are calling Israel’s 9/11?

Again, we don’t have many facts yet. But some evidence is emerging. A Hamas spokesman has credited Iran with supporting and green-lighting the attacks. That’s not a smoking gun, but it’s entirely possible — even likely — that Iran’s fingerprints are on this operation.

Iran has supported Hamas for years in its efforts to undermine Israel. Why would Iran sponsor an attack on Israel now?

Iran Wants to Block Israeli-Saudi Peace Talks

The most compelling answer is to sabotage a potential peace deal between Israel and Saudi Arabia, Iran’s two greatest adversaries in the region. Iran wants to keep them divided. Israeli-Saudi talks had recently been making progress, so Tehran wanted to stop them in their tracks.

How does this weekend’s attack benefit Iran?

Saudi Arabia supports Palestinian independence. Iran hopes that the Hamas attack will generate a massive Israeli retaliation in Gaza, where Hamas is based. The Saudis would have to side with the Palestinians, which would drive a massive wedge between the Saudis and Israelis.

Tehran hasn’t hid its hostility to a potential Israeli-Saudi deal. Just last week, Iran’s Supreme Leader Ali Khamenei actually said that regional “countries that make the gamble of normalization with Israel will lose.”

That comment was aimed mostly toward the Saudis. And now, this weekend, Hamas attacks Israel.

Well, it appears that Iran’s gambit has worked. Today the Saudis informed U.S. Secretary of State Antony Blinken that they’re ending all negotiations on normalizing relations with Israel.

What if It Spreads?

The greater danger is that the conflict can spread. Iran also sponsors Hezbollah, the militant/terrorist group operating in Lebanon.

Hezbollah has launched limited attacks on Israel. If those attacks expand, Israel could be faced with a two-front war.

Israel could even attack Iran directly, which could trigger a regional war. We’ll just have to wait and see how it all plays out. But if Israel does ultimately engage in large-scale combat operations for an extended period, it might be constrained by ammunition shortages.

To help support Ukraine, earlier this year the U.S. reportedly sent Kyiv 300,000 155-millimeter artillery shells that had been stockpiled in Israel. Those shells were intended for the Israelis in case it needed them.

Israel may only have about 20% of that stockpile left. If Israel does end up waging a two-front campaign against Hamas in the west and Hezbollah in the north, that shortage could represent a serious issue.

Israel does have a very powerful air force that could drop a lot of ordinance, but bombs are much more expensive than artillery shells and can’t deliver the sustained firepower that only artillery can provide.

That just goes to show that the war in Ukraine has affected military balances in other regions around the world, as stockpiles have been whittled down to support Ukraine.

It’s also possible that this weekend’s attack not only represents a failure of Israeli intelligence, but U.S. intelligence. U.S. intelligence efforts have been so heavily focused on Ukraine, other regions have been neglected, including the Middle East.

The Economic Impact

We also have to consider the economic impact of this weekend’s attacks. Oil prices jumped 4% today, to over $86.

If the conflict spreads, it could dramatically increase oil prices. If oil shipments through the strategically pivotal Strait of Hormuz were shut down, it could result in a $20–30 increase in oil prices.

For a global economy already showing signs of weakness, such an increase in oil prices would easily tip economies into recession — including the U.S.’ The signs are already there.

The EU is already in recession and Japan and the U.K. are close to zero growth and heading toward recession fast. Within the EU, individual recessions have hit in Germany and Ireland, with Italy and France showing growth barely above zero.

Then there’s China. The idea of a real recession in China may seem incomprehensible, but we may be witnessing one. The “reopening” narrative following the end of the ridiculous Zero COVID policy was always a myth (and I said so last year) but Wall Street bought into it until the data made its failure undeniable.

Today, China is not only underperforming the narrative, it’s slipping close to actual contraction. The point is, the EU, China, Japan, the U.K. and others are in recession or close to it. Can the U.S. be far behind?

The U.S. Case

There are many signs that it is. Many are technical in nature and I won’t get into them today. It’s enough to say that all of the technical signs are unusual and all point in the direction of a recession. They all have good track records of predicting recessions going back to the 1970s and earlier depending on the time series.

One of the best signs of a recession is when more mainstream or middle-of-the-road economists start sounding the warning. There are perma-bears who call for recession constantly (and everyone who does that is right eventually; recessions do happen).

I’m not a perma-bear, but I do use predictive analytics to look as far ahead as possible so I can be a bit early in the warning game. But economist Mohamed El-Erian is not in either camp. He generally expects strong growth and is an optimist even in the face of adverse data.

Now he’s warning about a recession. So when even he warns of a recession, you can be fairly certain that it’s either already here or arriving soon.

I’ll continue to offer my forecasts using the best methods available and ample data. But one of my data points would include a warning from El-Erian.

Now throw a potential Middle East war into the mix. Investors take heed.

The Daily Reckoning