Before Equilibrium

Before Equilibrium

A market at war can look optically cheap long before it becomes investable. One European fund learned that rule in 2022. It cost them roughly seventy-five million dollars.

The rule itself is simple. Do not buy the rebound in a market exposed to an escalatory conflict until that conflict has reached a stable equilibrium. The execution, in the middle of a geopolitical shock, is not simple at all. Valuations fall, diplomatic headlines flash across terminals, and every instinct built during a decade of calm whispers that the floor must be close. The floor is almost never close.

What follows is a near-verbatim account of how that mistake was made, the three rules that came out of it, and the question an investor now has to answer about Iran.

Reading time: 7 min

01 · The tradeThe fragile signal

In the run-up to Russia’s full-scale invasion of Ukraine, the fund was positioned underweight Russia. For nearly two months, the buildup of Russian forces at the Ukrainian border made it increasingly clear that something could go badly wrong. Russian equities fell sharply during that period, validating the initial caution. The fundamentals and the tape agreed: hold back.

Then came a fatal mistake.

On 7 February 2022, Emmanuel Macron met Vladimir Putin in Moscow amid a last-minute diplomatic push. After the meeting, the market took the signal as evidence that diplomacy might still prevail. The fund’s managers allowed a fragile diplomatic signal to override the discipline of their original analysis. They started buying Russian assets again and moved back to an overweight position.

The reasoning was simple, and disastrously wrong:

The market had already fallen significantly.
Valuations looked attractive.
Surely most of the downside was already priced in.

It wasn’t.

In escalating conflicts, valuation stops mattering. Markets stop trading on fundamentals and start trading on survival, access, liquidity, sanctions, and regime risk. Those five variables have no historical multiple attached to them. They are priced by the hour, and they never move in the investor’s favour.

Then came 24 February 2022. Russia launched its full-scale invasion of Ukraine. At 5 a.m. that morning, the two co-managers rushed into the office and began liquidating the Russian exposure as quickly as they could. But by then, liquidity had already deteriorated severely. They were only able to exit roughly half of the position before trading effectively shut down.

The other half remained stranded. The loss, by the time the dust settled, was around seventy-five million dollars.

02 · Three rules, bought at $75MThe ruleset that came out of it

That experience left one rule, and three corollaries, that have not been forgotten.

Headlines

Do not trade on incremental positive headlines.

In an active conflict, markets seize on fragments of optimism: a negotiation headline, a diplomatic visit, a temporary pause, a rumour of a deal. None of those establishes equilibrium. Treat them as noise until the underlying conflict says otherwise.

Valuation

Do not rely on drawdown as a valuation argument.

A market down 20% is not necessarily attractive. In geopolitical crises, repricing often has only begun. Price is what the market has already digested. It is not a measure of what the market still has to.

Regime

Wait for the regime to stabilise before underwriting risk.

A durable opportunity emerges only once the conflict produces a new equilibrium: a clear strategic outcome, mutual exhaustion, or the abandonment of maximalist positions. Until one of those lands, conviction is cheap and expensive at the same time.

03 · The Iran questionThe ruleset, reactivated

The ruleset had been dormant for three years. It is relevant again. The US–Iran episode is not identical to Ukraine, but the geometry rhymes: an escalatory conflict, a market tempted by optical cheapness, a set of diplomatic signals whose durability is not yet knowable. Managers who reach for the rebound before the regime stabilises are making the 2022 trade with a different map.

The Quiet Regime Change laid out six forces re-pricing the world over the next three to five years. This piece is the discipline that sits underneath all of them: know which regime you are in before you price what belongs in it.

By Blognosis

Editorial research · PortfolioDoc