There is an old saying on Wall Street that stocks take the stairs up and the elevator down. In the last ten weeks, we have seen the opposite pattern: Stocks slowly declined as oil prices rose, but then ripped higher on hopes that the Hormuz Crisis is coming to an end. Even the recent flare-up in hostilities doesn’t seem to unsettle the market anymore.
Buying the dip has been such a successful strategy for so long that investors have turned a blind eye to downside risks. The fact that earnings estimates continue to grind higher has only emboldened the market.
The problem is that the Hormuz Crisis is still very much here with us. The U.S. and Iran are restarting negotiations, and the outlines of a deal are becoming clear. However, vessel traffic still remains impaired, with risks to the real economy mounting. We agree with the market that the geopolitical crisis finish line is within view. But there is still a risk that things go totally wrong, and that is not priced in.
President Trump is open to more negotiations, as are his Iranian counterparts. Even if a deal is not accomplished, the two sides could declare a victory, and the market moves on. That outcome is already largely priced in by now, so the danger is that the world may get disappointed as further twists and turns in this saga emerge.
For now, we remain in the optimistic camp. That means that we think Europe and Japan will start outperforming the U.S. market again. This should be helped by a further decline of the USD. If we are wrong and the Strait of Hormuz stays closed for another 2 months, there is not much time before a global recession begins. Bonds would be an obvious hedge against recession, despite the recent inflation-induced sell-off.
From the beginning, this conflict was always meant to be a “short excursion.” A military action can change over time as events evolve, but the ultimate constraint remains a limited U.S. military presence in the region. The U.S. entered the conflict with eight destroyers and no ground troops deployed.
The other material constraint is the median American voter, who does not want this conflict. If the conflict does not end soon, President Trump may be looking at big electoral losses in the upcoming mid-term elections, which will diminish his political capital and see moderate Republicans cross the Congressional aisle on many issues.
The good thing is that the ceasefire is more or less holding, with the May 4th burst of missile attacks as the lone violation thus far. Traffic is continuing to trickle through Hormuz, supporting global energy balance thus far. This suggests that the positive scenario of a “new geopolitical equilibrium” is holding, for now.
Despite this, we do not believe the inflationary shock from this crisis will be transitory. Normally, energy shocks are most definitely transitory. But we are in a world where the underpinning geopolitical context of American hegemony is transitioning to a multipolar one. This requires a re-wiring of the world’s energy, supply chain, defense, and trade infrastructure. This means that every country will invest more in its own supply chains to reduce its dependence on other nations. This could be good for global economic growth, but it will likely also push up the prices of certain resources.
So, we should be prepared to see higher long-term inflation expectations. But we also expect the Warsh Fed to be the least sensitive global central bank to this reality, fueling equity markets higher.
- An Uneven Inflation Shock
- A Strong Earnings Season
- AI is Still the Business Cycle
- Can Oil Fall Back to $50?
- Yen Capped at 160
- Our Portfolio Positioning
An Uneven Inflation Shock
The April inflation data show that the global energy shock is feeding through unevenly, with higher price pressures outside the U.S. Longer delivery times were widespread across developed markets, and input prices rose.
Price pressures are more widespread in Europe and Japan, reflecting their greater dependence on Hormuz for energy and petrochemical supply. Yet this shock differs from that of 2022: the global economy is much weaker than it was then. Second-round effects, where stronger growth lifts wage growth, are unlikely at this stage. The Iran war is already the fourth inflationary shock of the 2020s, after the COVID reopening, Russia’s invasion of Ukraine, and the 2025 U.S. tariffs. Central banks can do little against a supply-side inflation shock and are likely to hike meaningfully only if long-term inflation expectations become unanchored. Long-term expectations remain anchored for now, but repeated supply shocks have made them more fragile.
We therefore expect most major central banks to remain on hold until more clarity emerges regarding the shock’s impact.
The Fed might be a different story. We think it is likely that Kevin Warsh will be appointed the Fed Chairman on May 15th. We also think he is open to further rate cuts in the U.S. this year.
A Strong Earnings Season
A key reason why equity markets decided to ignore the Iran war and start moving higher is strong earnings. Earnings have pushed the S&P 500 to new highs despite geopolitical uncertainty, with the profit cycle remaining robust. Equities decoupled from oil prices and interest rates in April after initially tracking them during the Iran conflict, but this divergence does not signal complacency. The macro backdrop does not point to a recession, and there is no justification for underweighting risk assets at this stage.
Earnings expectations appear reasonable in isolation, but are ambitious given the expansion’s age. Still, structural supports for elevated profit margins remain in place, and the ongoing AI capex cycle differentiates this expansion from prior ones. Late-cycle bull markets often accelerate, raising the possibility of a blowoff rally similar to past episodes.
AI is Still the Business Cycle
AI remains the central market thesis despite the oil shock. Recent hyperscaler results reinforce the view that capital investment in AI remains intact and is showing early signs of positive return on investment. The Hormuz closure has ended the broadening trade that dominated early 2026, squeezing consumers globally and pushing easy monetary policy off the table for most central banks this year.
The AI investment cycle is what separates this shock from prior oil episodes. Firms are spending regardless of consumer health, buffering the economic cycle against demand destruction. EU households face disproportionately greater strain than U.S. consumers, and with the U.S. carrying substantially higher tech exposure, American equities have been outperforming since the geopolitical conflict began.
What also helps is that institutional equity exposure has fallen sharply since the war started, creating a wall of worry for markets to climb. Positioning and investor sentiment are considerably lighter than pre-war levels, even as earnings remain strong.
When does it all end? Predicting the end of a capital expenditure boom is tricky. They can last longer than you think. However, history is teaching us a lesson: when major key players all IPO, it is a warning sign. Major IPOs peaked during the Internet boom in 2000 and at the end of the commodity boom in 2011.
So, if SpaceX, OpenAI, and Anthropic go ahead with their plans to IPO, this would create new public companies with a combined market value of over $3 trillion. As such, we could at that point become more cautious about the overall outlook for the tech sector and the broader equity market.
Can Oil Fall Back to $50?
Financial markets want to move on from the Iran war and its resulting oil supply crunch. The S&P 500 has broken out to record highs, even as oil prices have surged again. With tensions in the Strait of Hormuz elevated, fears of a worsening oil supply crunch remain both intense and widespread.
Nevertheless, history has shown that every major surge in oil prices is often followed by a subsequent crash of more than 50%. Of course, some of these crashes can be explained by recessions, while others mainly reflect oil gluts as key producers rush to ramp up production to capitalize on high prices.
We suspect a similar boom-bust outcome could unfold, that is, a sharp fall in crude prices following the end of the Iran war and/or the reopening of the Strait of Hormuz.
Should the current Iran war and oil supply crunch persist, it will further accelerate changes in the energy demand structure. And once an economy shifts away from crude oil, it rarely shifts back.
Yen Capped at 160
Japan’s intervention reinforces 160 in USD/JPY as a near-term ceiling, but it does not yet change the broader macro backdrop. Estimates suggest the Bank of Japan intervened with approximately $35 billion. The policy move reinforces the 160 level in USD/JPY as a clear line in the sand for Japanese officials.
Intervention can cap further yen weakness, but it cannot generate a lasting rally, because the macro backdrop still works against the yen. Oil prices remain high, the Fed is not cutting rates, Japanese real rates remain far below peers, and low implied volatility continues to support carry trades where JPY is used as the funding currency. Intervention decisions typically hinge on both speed and level. The recent depreciation had been steady rather than disorderly, which reduced urgency on volatility grounds. While the yen is weak on valuation grounds, the move also reflects widening real yield differentials and a worsening terms of trade. Intervening against that means leaning against the macro trend.
The timing also looks tactical, as this is the start of Golden Week. The Golden Week holiday creates conditions that make intervention easier as markets are thinner and less liquid. Japan also intervened at the start of the 2024 holiday period. Intervening in an illiquid holiday close lets officials maximize impact without spending as much. With the intervention, upside in USD/JPY looks limited in the short-term, but the longer-term risk/reward is still in favor of yen strength, as we think the Bank of Japan will have to raise interest rates at some point.
Our Portfolio Positioning
It looks like the war in Iran is now in the rearview mirror for markets. However, we will keep a close eye on traffic through the Strait of Hormuz, as energy shipments will need to recover in the near term to avoid further structural economic damage.
In our core portfolios, we still have a slight defensive tilt, with an overweight in Europe and emerging markets, which is helping the portfolio this year. Given the structural economic factors, we remain comfortable with the current positioning. While U.S. assets have outperformed since the start of the Iran War, we expect international markets to resume their outperformance.
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