Markets at record highs despite war in Iran

Key Concepts

• "Buy on the sound of cannons": A contrarian investment strategy suggesting that markets often rebound after the initial shock of geopolitical conflict.
• Earnings Growth: The primary driver of stock market performance, with a focus on analyst consensus versus actual behavioral outcomes.
• Good vs. Bad Inflation: A distinction based on whether producer prices (PPI) are growing faster than consumer prices (CPI), which supports corporate profit margins.
• Fear Premium: The portion of oil prices driven by geopolitical anxiety rather than actual supply-demand fundamentals.
• WTI vs. Brent: The pricing discrepancy between the North American oil benchmark (WTI) and the international benchmark (Brent), influenced by transportation, insurance, and oil grade.
• AI Capex Buildout: The debate regarding whether massive capital expenditure in Artificial Intelligence will yield sufficient returns to justify current valuations.

Market Outlook and Geopolitical Strategy

Tally Leger, Chief Market Strategist at Wealth Consulting Group, argues that despite high energy prices and ongoing instability in the Middle East, the stock market remains resilient.

• Geopolitical Playbook: Leger cites the Nathan Rothschild adage, "buy on the sound of cannons," noting that historical data shows 12-month forward returns following Middle East conflicts involving the US and Israel average nearly 20%. This serves as a "tailwind" for optimistic market outcomes.
• Earnings Fundamentals: Earnings are identified as the ultimate driver of stock prices. Leger notes that while the bottom-up analyst consensus for Q1 earnings growth is 13%, historical behavioral patterns suggest an "undershoot" of about 7%, potentially leading to 20% actual growth.

Inflation and Energy Dynamics

Leger addresses the inflationary impact of rising oil prices, emphasizing that investors should not overreact.

• CPI Impact: Gasoline accounts for less than 3% of the US Consumer Price Index.
• Margin Protection: Leger distinguishes between "good" and "bad" inflation. As long as producer prices grow faster than consumer prices, companies can maintain or expand margins, which supports earnings growth.
• Energy Security: Leger dismisses fears of a US energy crisis, noting that the US is currently at record production levels and relies heavily on secure North American imports from Canada and Mexico. The current spike in WTI (West Texas Intermediate) is characterized as a "fear premium" rather than a reflection of physical scarcity.
• Benchmark Discrepancies: Leger clarifies that the perceived premium of WTI over Brent is often a result of "wonky" contract comparisons (e.g., comparing different delivery months). When comparing apples-to-apples (June contracts), WTI trades at a $10+ discount to Brent, reflecting regional differences in transportation, insurance, and oil quality.

Portfolio Strategy and Sector Allocation

• Trimming Energy: The firm has trimmed energy holdings to protect gains, viewing the current price spike as "transitory."
• Consumer Discretionary: The firm has begun "nibbling" in the consumer discretionary sector, a trade that has performed well over the past month.
• Technology and Small Caps: The firm maintains a "steady as she goes" approach to technology and small-cap stocks, as these positions continue to yield strong results.
• AI Investment: Regarding the debate over excessive AI capital expenditure, Leger argues that analyst revisions and corporate guidance confirm that the technology sector is leading the market. Furthermore, tech is acting as an enabler for a "catch-up phase" in other sectors, including industrials, materials, and mid/small-cap stocks.

Conclusion

The overarching perspective presented is one of cautious optimism. By focusing on fundamental drivers—specifically earnings growth and margin expansion—rather than geopolitical noise, Leger suggests that the market is well-positioned for continued growth. The strategy emphasizes protecting gains in volatile sectors like energy while maintaining exposure to technology and rotating into sectors poised for a catch-up phase.