The market is weighing the severe geopolitical risk of a US-Iran conflict against the strength of the US earnings outlook. The S&P 500's composition, heavily skewed towards tech and AI, is seen as resilient to energy price shocks that would primarily impact a small slice of consumer cyclical stocks.
The conflict has escalated to a US naval blockade of Iran, disrupting a critical artery for global oil supply. Iran's ability to disrupt shipping relies on creating a perception of risk, which is difficult to neutralize even with military escorts, threatening a prolonged period of reduced oil flow.
Strong corporate pre-announcements suggest the US earnings backdrop is accelerating, potentially leading to a return of 'US exceptionalism'. However, this strength, combined with sticky inflation, creates a significant risk that the economy becomes 'too hot,' forcing the Fed to abandon rate cuts and potentially hike further.
After punishing companies for high AI capital expenditures in late 2023, the market has caused a significant compression in tech valuations. Relative valuations for the tech sector and Magnificent Seven are now near 10-year lows, making them appear attractive on a fundamental basis again.
Keep pulling the thread on Bloomberg Surveillance.