Why So Bullish? Markets Cling to Iran Hopes | Prof G Markets

So, I think that, you know, when you look at the multiple compression that has occurred off of what has gone on in the Middle East, you have to be somewhat optimistic. Um, you know, technology stocks, which make up, you know, the largest sector in the S&P 500, they're now trading below 20 times earnings with accelerating earnings growth. That's actually the lowest multiple since back in '22. Uh, you've now, you know, gotten past the liberation day multiple. So, I think you have to be optimistic as a long-term equity investor here. Um, you know, what I would say about what's going on, you know, in the oil markets, I mean, obviously, uh, you know, the oil sector was extremely strong in the first quarter. I think it was the second best quarter since 1989. And energy stocks had two distinct advantages going into the year. The first is that they were historically cheap and then you had the exogenous shock that occurred with the oil spike. So I think that, you know, when you look at what's going on, you definitely have to be optimistic as you look at more cyclical areas. Technology, financials have really been beaten up. Uh, and even though the broader markets are only down, you know, six, seven percent, the multiple has compressed far below what I think investors might expect given, you know, kind of a more small pullback on a total return basis.

Yeah, there's a lot of pieces swirling around. You know, you have the concerns around private credit. You now have, you know, shock inflation. Um, that's very different than hot inflation, right? So, you have concern that the Fed may not be able to cut as much as folks thought. So, I think that, you know, those are two obvious concerns. And then you have, you know, the exogenous shocks of how long does this conflict in the Middle East drag out? This looks like a bit more of a complicated situation relative to Venezuela. So, I couldn't agree more, Ed. You know, when you look at what's going on in technology, that was selling off well before this news came out. And that really is around concerns around can these technology companies hold their margins? Is that going to be possible to do with the advances in AI? It's really ironic that Nvidia, the largest stock in the S&P 500, is disrupting its own siblings to some degree in the software space. No one really expected that. What's fascinating though, and I was looking at this today, there's not been any change to earnings and margins for the large software names yet. So either the market just wants to reprice in anticipation of earnings cuts or it's just the market recalibrating and kind of a broadening out trade. We've talked about concentrated leadership in the market for some time. So this may be the market just reshuffling, digesting and compressing some of those multiples as we, you know, kind of march forward because the earnings in technology stocks have not changed. It's just been a multiple compression story. So, you have a lot of information, you know, with private credit, as I mentioned. Uh, that's been another concern. I think that that parlays into, you know, is the Fed going to have a harder time reacting, uh, if you have hotter inflation numbers coming out to what could be a brewing problem in credit and a lot of that private credit has funded a lot of the areas in software. So all these are connected whether it's credit, interest rates and how that impacts the CPI readings coming out of, um, you know, the result of the oil shock.

I think you hit the nail on the head. Um, I mean, I just pulled up Micron because I wanted to get it exactly right. Micron is growing forward earnings at 739% and trades at five times earnings. So, uh, that is, um, the market telling you it doesn't know what to do with the earnings profile. The earnings growth is so egregious to the upside. The market does not know what to do. So the multiple being pushed down even though the stock has gone up because the earnings have accelerated so dramatically. The same thing is occurring with Nvidia. Nvidia is growing at 80 and it's trading below 20 times earnings. Uh, that's, you know, at a parity almost with the S&P 500. So, I couldn't agree more. I don't think folks know quite what to do with this. I think that it's really going to come down to capex spend from the hyperscalers. We'll get a read on that as we roll into quarterly earnings. But I will say this is one risk that, you know, is out there. To the extent that, you know, Microsoft had a really tough quarter, to the extent that, you know, the Mag 7 continues to struggle in the equity markets, uh, that is going to put pressure on management's ability to continue funding capex. You know, historically, they've done it from free cash flow. Now, they're having to tap the debt markets. So, the market will only tolerate that so far. So, I think that, you know, what plays out here with the war in Iran and the CPI continuing to come in is going to be really critical because if the equities prices stay weak for the MAG 7, you know, those are the customers for many of the chip and memory stocks. So, it's going to be tougher for them to continue the capex cycle. So, we're going to have to see how those earnings shake out. But I will tell you as I sit here today and I look at where valuations are and look at where earnings are and I look at the sectors that did well, some of the more defensive sectors, energy, utilities, REITs, um, I'm optimistic that we could push through this and I think that the current administration really does not want a war on their hands. The midterms are coming up. Um, I think that there's going to be a lot of pressure to resolve this relatively quickly.

And move out. And particularly with, you know, the administration saying they want lower rates, it's going to make it way harder if you continue to push oil prices because the Strait stays closed. Uh, and you know, that's 20% of the world's oil supplies going through there. So, uh, one point that I will make that is fascinating, I haven't heard anyone talk about this. It relates to oil. So, in 2022, you had two real bad things going on, right? You had interest rate hiking cycle and then you had the Ukraine, um, you know, Ukraine was invaded by Russia and you saw oil prices shoot up and that was a really tough period for the market because you had the Fed raising rates to deal with inflation from COVID and supply chain disruptions and on top of that, uh, you know, you had a war going on so it was really tough. And what occurred was you saw the Baker Hughes rig count really ramp up oil production to compensate for the higher oil. That has not happened yet. Uh, the Baker Hughes rig count has not moved higher. We're going to get a reading tomorrow on that. But that's also interesting. You know, that would need to move up, I think, to kind of release some constraint. If that doesn't, you actually could have a scenario where the gold refiners and the energy stocks maybe continue to participate in the market, but you see technology, financials, and other cyclicals kind of play a catch-up trade as well.

Yeah. So, I will tell you that we have taken some energy profits. Um, we were overweight energy. Um, and that was not a call based on anything in the Middle East. It was a bottom-up call in valuation. So, we were fortunately positioned.

Yeah. So, you know, we'll take it. Um, but what I would say is that we've been adding to some of the more cyclical areas like financials, like industrials. Um, you know, financials have went through a really tough time particularly the regional banks back in 2023 with the failure of Silicon Valley and First Republic. Um, you know, you're getting a lot of multiple dislocation, price to books are attractive there and the yield curve has steepened. Now we'll see what happens here with the Fed. Uh, you know, if they don't cut, that's going to put a little bit of pressure on the yield curve, but my expectation is that you should have a steep yield curve. That's a healthy sign for the economy. I don't think you want the 10-year parity with the Fed funds rate, which is basically where we are today. So if that steepens, banks should fly. Uh, they've got great balance sheets, they're not exposed to private credit. I like financials here. And then, you know, as I mentioned, you know, some of the industrials in the capital goods space, industrial machinery, these names look attractive. And you know, I think the market is trying to recalibrate, doesn't want to pay for longer duration assets, meaning the software trade, or is more interested in cash flow generative hard assets. And I think the market is recognizing that actually the AI trade needs hard assets and so maybe it's overly discounted these areas relative to, you know, the technology trade. So I think that you could see a compression there, you're already seeing it. So yeah, I'm optimistic. You know, we could see a leg lower, I would not be surprised if that happens. But that being said, I think that you should be adding to equities here. Uh, given that you're, you know, you're getting the S&P, you know, it was under 20 times yesterday, right?

You know, I think the playbook is what happened with the tariffs. Um, he drew a hard line and the market ultimately forced his hand. It's not unlike when Mark Zuckerberg said, um, you know, we're going to rename the company Meta, we're going to do the metaverse. And then the market took the stock down 67%. He said, 'Whoops, it's the year of efficiency.'

So, the market ultimately dictates how leadership has to respond. So, they can draw hard lines, but Trump is, he does seem to be very aware of what's going on in the equity markets. And to be honest, I don't know if that's not improper. I think that a leader of the country should be focused on what the largest companies in the world are doing. So I actually think that if he comes out with a more negative stance and the market reacts very negatively, my expectation is that that will be pressuring him because again, to the extent the markets stay negative, that starts to put pressure on the capex cycle, that puts pressure on the AI buildout, that puts pressure on tensions with China and their buildout. So there's all this geopolitical chess that occurs with a weak equity market. I think for America to be in the best position, we need a strong equity market. And I think that that's going to ultimately be the lever that he uses or that he's going to be considering when he thinks about how he deals with the Iranian conflict. And I think that my personal opinion is it's already proved to be more complex than he anticipated.

Thank you.