The wall of worry gets another brick

Markets generally need walls of worry to climb gradually higher, and this weekend US equity markets received another brick. Add that to the collection we have been watching, particularly AI disruption, valuation concerns around asset-light businesses, private credit, renewed tariff uncertainty, and the direction of inflation. While the war in Iran seems likely to end positively, there is no certainty it will or that a major disruption in the world’s energy supplies will not occur. Against this backdrop, we are maintaining our outlook for more modest — but volatile — positive single-digit returns in US stocks through 2027. We are staying overweight stocks and tilted toward Value/defensive as we believe the underlying forces favoring these stocks remain very much in place, and even strengthened, by the weekend's developments. At the same time, we are closely monitoring oil market news, as a material breakdown there represents the most credible risk to the current bull market.

Some details:

1. The concerns around AI disruption and valuation levels on asset-light businesses are so far unaffected by the Iran war. Although currently upstaged by the news, these worries are likely to continue to plague growth stocks in the months ahead as we outlined in "The Good News and the Bad News." Bargains will no doubt arise, but stock picking will be key.
2. The pickup in defense spending already underway should accelerate, helping the Value indices, in which most defense/industrial stocks reside. In early February, Congress approved the nearly $850 billion 2026 US defense budget, which included $28.8 billion for munitions and hypersonic missiles. At the current rate of deployment, this seems woefully inadequate. For example, each Patriot missile battery costs more than $1 billion to produce and every missile fired has a price tag of $4 million. Many of us spent the weekend watching hundreds, if not thousands, of those missiles being fired to intercept incoming projectiles. While they appeared quite effective, the costs of using $4 million missiles to shoot down $20,000 drones will add up quickly.
3. The temporary shutdown in energy supplies may help offset the short-term oversupply in oil globally, supporting the energy sector (another value component). The Strait of Hormuz serves as a gateway to the Persian Gulf. Nearly 20% of the world’s oil and gas supply flows through it daily — roughly 20 million barrels of oil per day. With the potential for mining and drone strikes, that key shipping lane is effectively shut down. While the bulk of that oil heads to Asia, where the Chinese have ample strategic reserves, a lasting closure could significantly impact the price of oil.
4. But oil needs to hold under $90 a barrel, in our view. While some buoyancy in oil prices could be good for the Value indices, a sustained, severe rise would be another matter. Prices that settle above $90 could, in our view, pressure the economic recovery we are anticipating in the lower end of the economy. That could also reignite inflation and take the expected Federal Reserve cuts off the table. Energy is roughly 6% of the headline basket. With prices below $70 a barrel for the bulk of 2025, oil has spent the better part of the year in deflationary territory. A rise to $90 could quickly invert that relationship, spiking headline inflation measures. It is unclear whether the Federal Open Market Committee would look through this to their preferred inflation measure, Core Personal Consumption Expenditures. Regardless, oil impacts many other prices indirectly, as it is an important input in transportation costs for supplying goods to our local shelves.

For now, we are treating the Iran War as a temporary market headwind that should have limited impact on our call for high single-digit returns broadly in US stocks, along with returns better than that in Value, small cap, and emerging markets. Should the war drag on and global oil supplies be permanently damaged by events, we would reassess our view. At present, however, this episode looks more like just another brick in the healthy wall of worry.

Read more about our views and positioning at Capital Markets.