With what appears to be a deal with Iran taking shape and the reopening of the Strait looking increasingly likely, the two most important questions we are asking ourselves are: 1) How will global inflation expectations respond, and 2) will markets revert to the trends and themes that were working before the conflict began?
Easing Inflation Expectations to Provide Rate Relief
The direction of global inflation expectations will be one of the most important variables to monitor in the coming weeks if a deal is ultimately signed. Such an outcome would likely ease one of the primary concerns facing central banks today: the risk of renewed inflationary pressure stemming from higher energy prices. A moderation in inflation expectations could help reverse some of the hawkish tone that has recently emerged in central bank communications, stabilize the rise in global bond yields, and potentially support multiple expansion in areas of the market where fundamentals remain strong. Under that scenario, the yield curve would be expected to steepen as front-end yields decline in anticipation of future rate cuts.
However, as of today, the yield curve has shown little reaction to the latest developments, and rate-cut expectations remain largely unchanged. Perhaps the most noteworthy development came from Japan last week, when officials indicated that all oil imports would bypass the Strait of Hormuz beginning in July. In many respects, the clock has started ticking on the strategic relevance of the Strait itself. Whether it remains open or closed becomes less consequential if major importers successfully adapt their supply chains. Meanwhile, the decline in gasoline prices should provide some relief to consumers, a trend that is already beginning to materialize. The broader economic implications are meaningful, creating an additional tailwind for an economy that was already on relatively solid footing. For markets, the most constructive outcome would be a return to a narrative in which central banks are once again discussing rate cuts later this year. If oil prices retreat toward $60 per barrel, that possibility cannot be ruled out.
The Return of the Broadening Trade
If you recall, the dominant market theme at the start of the year was the broadening-out trade, with investors favoring the equal-weighted index over its market-cap-weighted counterpart. As we sit here today, fundamentals have remained strong across the market-cap spectrum, and it would not surprise us to see that narrative reemerge if a deal is ultimately signed. The strength in Technology has been particularly notable. With fundamentals outside of Technology and Communications appearing to have narrowed somewhat during the second quarter, just as a MOU is potentially being signed, the hurdle for many sectors outside of those market leaders may be lower than investors expect. Consumer Services companies, in particular, appear well-positioned to benefit in the near term, although the more important question is whether such a shift can prove sustainable over a longer horizon.
Ultimately, the answer may come down to one factor: whether investment spending in the technology sector continues at its current pace. If it does, it remains difficult to take a bearish stance on the broader market. Technology continues to be a powerful driver of earnings growth, capital spending, and investor sentiment. One observation we continue to make is that the least-discussed sectors in investor meetings are the traditional defensive areas of the market, such as Consumer Staples and Health Care. Whenever interest in a sector becomes this limited, it naturally raises the question of whether something is being overlooked. For now, however, market participants appear far more focused on cyclical growth opportunities, and the path of least resistance for equities still seems to be higher.
Source: Strategas
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments. Data provided by Refinitiv.
Sincerely,
Fortem Financial
(760) 206-8500
team@fortemfin.com
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