Today's number, 54. That's how many years it's been since we last went to the moon. Back then, many thought that by 2026 we'd have flying cars and space hotels. We don't have that, but we do have NFTs.
Welcome to Prof Markets. I'm Edson. It is April 9th. Let's check in on yesterday's market vitals. The major indices rose on news of the ceasefire. More on that in a second. Brent crude plummeted. The dollar fell and Meta stock popped more than 8% after releasing its new AI model, Muse Spark. Okay, what else is happening?
The US and Iran agreed to a two-week ceasefire, making yet another Taco Tuesday. The two countries came to an arrangement just hours after Trump threatened to annihilate Iran. Under the deal, the US agreed to suspend strikes and Iran said it would reopen the Strait of Hormuz. Markets celebrated the news. The S&P 500 and the Nasdaq surged nearly 2.5% and the Dow jumped more than 1,300 points on Wednesday. Meanwhile, crude fell from $110 to $90 overnight before settling around $95.
However, the ceasefire is already showing cracks. Iran halted oil tanker passage through the strait after Israel attacked Lebanon. Iran and Pakistan claimed the deal covers Lebanon, while the US and Israel say it doesn't. Iran's parliament speaker also claimed the US has already violated three clauses of the proposal. The Iranian Guard says it's keeping its finger on the trigger ahead of talks with the US scheduled for Friday. Okay, lots to dive into here. We're going to discuss this move from Trump and what it means for markets. We are joined by Robert Armstrong, commentator for the Financial Times and author of the Unhedged Newsletter, as well as John Mowrey, chief investment officer of NFJ Investment Group. Thank you both for joining me. John, I'm just going to start with you because last week you and I discussed this and towards the end of our conversation, you said you think he's going to — you didn't say the word taco, but you said that he's not going to go through with this, and that is what happened. Let's just start with your reactions to what happened in this ceasefire and how the markets reacted.
Well, you know, I'll start by kind of simplifying what we were seeing as we kind of went into this week. Earnings are holding up, but multiples were not. And to me, that's really the story because, you know, if anything, estimates have gone higher and you were getting, you know, the tech sector at the lowest multiple going back to 2022. So this was really about multiple compression and you know this is all pointing to what happened in the oil markets and how that subsequently feeds into the CPI and how that subsequently feeds into the Fed's path for rate expectations. And as those expectations got pushed back, you started to see the multiples compress more and more and more even though there wasn't fundamental deterioration in the underlying stocks. And I think that's a real key point because I think a lot of times when people see sell-offs they think, hey, you know, that's because you know companies are doing poorly. That happens sometimes but in this case this was purely based on an exogenous shock and I think that all was trickling into how the Fed would move with interest rate cuts and those expectations. So you know you were getting multiples really down to some of the lowest levels we'd seen in many stocks in four or five years. So I'm not surprised at all to see the relief rally today because we got some clarity potentially on opening the strait which is 20% of supply as we talked about last week. So all those things trickle into okay if oil prices come in then that's going to potentially lessen the impact on the CPI and that will allow for the Fed to potentially revisit what the expectation for the market was which is multiple rate cuts over the next 12 months.
Right? That seems to be the hope and the expectation at least after the ceasefire was announced that if oil price — if we have a ceasefire, if the Strait of Hormuz is open, then that means the oil prices are going to come down, then that means we're going to see lower inflation than we expected, which means that the Fed is not going to hike rates or at least we'll maybe continue with the rate cutting cycle. I mean, I appreciate how you lay out how it all trickles down to asset prices ultimately, but the big question appears to be, or at least is to me, is it really open? Is the strait going to remain open? Is this ceasefire over? Rob, I'm going to turn it to you because you actually created the term taco, as I like to remind people over and over again. People are calling this a taco. Was this a taco? And what do you think this means for the markets going forward?
As much as I enjoy my pathetically small kind of fame I have for inventing this term, I don't think it applies very well in wartime. This is a term that made a lot of sense when we were dealing with domestic policy, specifically tariffs, where Trump was really in charge. So he could make a grotesque threat and withdraw it and the resulting kind of wave rolling through markets you could trade here. He's tangled up in a very complex multilateral situation as we've just seen demonstrated today. Like nobody seemed to tell the Israelis that the ceasefire said that they shouldn't bomb Lebanon. Somebody, you know, somebody bombed that Saudi pipeline today, the Hormuz strait alternative. So it's not a situation where Trump can flip a switch anymore. And I think so I think it's very different. Now, did he back down in general? Well, the Iranians have come to the table and at least nominally agreed under certain conditions for the strait to be open. So, did he get nothing? Did he back down for nothing? I don't think it's that clear. So, I'm going to sort of argue against myself and say taco doesn't quite fit here. I do also want to mention though, I think John's point about multiples is very to the point. I mean, it's very interesting in this context that estimates, earnings estimates have just been rising steadily through this whole war. And like the stock is — that's the reason that multiples are down so much is not just the stock prices have come down, but earnings estimates are up, right? And so there's nothing like the estimates for companies, what they're pricing in doesn't incorporate any of the damage that higher oil price might do to growth or consumption, right? It's not that that's not in there. So, you know, I think we're in a situation where different parts of the market are sending different messages. You know, it's an interesting moment.
Yeah. You wrote in your newsletter, you said, quote, 'Will the truth hold? Markets have decided that the glass is half full. Oil prices fell hard and Asian stocks rose on the news.' Unhedged, which is your newsletter, that's you guys. So basically, Rob, Unhedged still believes investors are underpricing the possibility that sustained high energy prices will push inflation higher and growth lower. Could you elaborate on that point, please, Rob?
Let me just lay it out in terms of a simple contrast. The stock market is almost fully recovered to where it was at the end of February. Not all the way, but I think it's within a few percentage points. Oil's at 96 after falling 17%. We started the war at $65. So, all is not back to the status quo in the oil market. And we've already seen today that this is a delicate situation and that things could go wrong in the strait. And even on top of that, when I talk to oil traders, they tell me it's going to take — even in the best case scenario, it's going to take a while for traffic through the strait to normalize. Months, not weeks, right? So, you know, how sensitive the US economy is to high oil prices, we can debate, you know, but I think there's a threat, not only an inflation threat, but a threat to growth and that it's probably a bit underpriced here.
Yeah, John, what do you make of that argument?
Well, I couldn't agree with Rob more in terms of, you know, it's going to take time for, you know, ships to start running through the strait again. So, I completely agree with that. Markets will move ahead of that. So, I think as an equity investor, you know, we have to be thinking about where markets will be before that occurs because equity markets are going to discount that quickly. So I think waiting for the headlines is always a challenge with investing in terms of slowing growth. I would also agree, you know, this is the real risk because, you know, higher oil prices are a regressive tax, meaning that that is a tax on, you know, everyone up and down really the global economy. It's not just Americans, it's everyone. And, you know, the point I would make about a regressive tax around oil, I think it's interesting because I think COVID really reshaped people's view on what costs were tolerable because the inflation was just so egregious. I mean we had the highest inflation since 1980. And when I think about how people tolerated that, I mean, I think it's been kind of amazing as an equity investor, but also as I look at how just the consumer dealt with higher inflation from hamburgers to cars to houses and everyone thought that that was going to push the economy into a weaker position and it ended up being much more resilient. So my expectation is that this time because consumers are, I think, better equipped to deal with the inflationary effects that they learned from COVID, I think that this could actually not be a mechanism that slows the economy quite as much. I think the real question in my mind tying back to the Fed is okay, you've got hot inflation and you've got shock inflation and those are two very different things. One is demand driven, one is supply driven. What I mean by that is right now we have supply-driven inflation on the oil side. Back in 2007-2008, oil was ripping because emerging markets were ripping, China was getting ready for the Olympics, you know, they couldn't get enough, you know, coking steel from Canada to build bridges, highways. So, that was a very different type of oil spike that we saw when Goldman came out and called for it to go to 200 back, I believe, in 2008. This is supply-driven. And the question to me is, will the Fed look through a supply shock? Because to Rob's point, if anything, this is a tax on the consumer. So you can make the case that actually you need to lower rates even more even though the CPI might tick up because this is not because the economy is running hot. It's because you're taxing all of the global consumers around the world.
Yeah, it's a really interesting point. It gets to the point of, I mean, it almost doesn't matter how we feel about it. What matters is how Jerome Powell feels about it.
Um, and he's got an unpleasant job right now for reasons John just made very clear. You know, he's getting it coming and going and, you know, I don't envy him, right? Because on the one hand, of course, you should look through it, right? You can't print molecules and consumers are already getting hurt. At the same time, if the market gets the impression that you're being soft on inflation, you know, you're playing with fire on that side too. So, it's a damn delicate game and I don't envy the guy at all.
We'll be right back. And if you're enjoying the show so far, be sure to like and subscribe to the Prof G Pod YouTube channel at the link below.
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Is there any way that we could — I mean, I guess before I ask that question, it sounds like we believe that ultimately when it comes to markets, I mean there are many reasons why this is important for reasons totally aside from markets, but it seems as though the big implication is what this ultimately does to inflation and what those inflation expectations do in terms of the Fed's decisions. And that seems a little bit stupid when you say it out loud, but ultimately it does seem like that is what's going to determine the market.
I would say there is a second channel. The first channel, which John just described brilliantly, is that channel that leads to what the Fed does. The other channel is — that's the inflation channel. The other channel is growth. So we put a regressive tax on consumers in an economy where there is not as much fiscal stimulus as there was in, you know, in 2020, where the job market is not getting worse but it's a little bit squishy already, right? No hire, no fire, it's not dynamic, where there's just a little bit of noise about credit problems in areas like private credit or consumer credit among poor consumers. Then you say, 'Okay, regressive tax on the poorest consumers. You know, real incomes go down. Consumption comes down a little bit. Companies start to feel the pressure. You know what a company does when it feels pressure? I better protect my margins. You know what I'm going to do? I'm going to fire someone, right? Save a little bit of money.' And you can see where this is going. And by the way, I should emphasize, I think John's optimism is well placed. I'm playing out the right-hand 10% of the probability distribution that there's a cascade from this regressive tax to lower consumption to companies cutting fat to the job market cracking and all of a sudden you're in a recession. Even though the American economy is not that sensitive to oil prices, you get this kind of crazy cascade in an economy that's a tiny bit mushy at one end anyway. You could see that being important. Knock on wood, none of that will happen. I think the highest probability is none of that would happen. But you can see that series of dominoes falling.
It's very clear to me how that would all play out. I mean, that's at least where my mind initially goes here. It's like, okay, we've had these escalations in Iran. Yes, the Strait of Hormuz is supposedly open now, but they're also charging millions of dollars for every ship that passes through. And then they're also closing it every other second in Bitcoin, which is a whole other thing to talk about. But it seems to me that this generally leads to elevated prices at a general level. No, we're not going to have $150, $200 a barrel of oil, but certainly it seems like oil prices are elevated. Certainly it seems like gas prices are elevated. Certainly it seems like fertilizer prices are elevated leading to elevated food prices, etc. And we are now seeing inflation expectations from various institutions. We were looking at Bank of America who put inflation above 4% by the end of the year. Does that then lead to lower growth which then leads to more layoffs because that's what companies are going to decide is the right thing to do in that environment which ultimately sounds like, okay, that's a recession. That's where my mind goes at least. But John, would you take issue with my mind going in that direction?
I mean, look, that's the right logical sequence. The fly in the ointment though is what is the duration of elevated oil prices. And so that's what's going on, right? That's why I mean there's pain points globally with what's going on with the strait because of the 20% supply that goes through it. I mean we don't buy any oil from Iran and China is the one that buys all the oil from Iran. I think 80% or plus. So this isn't about getting oil from Iran. This is about the global supply network which ironically is very similar to what the tariffs were about. That was global supply network and ironically that was very much what COVID was about. That was the shutting off of global supply networks. And so Americans are getting a real taste of what globalization did in terms of supply chain management. I think that the way you have to navigate this though is there are going to be companies that are able to pass through inflation easier than others. And as an investor, when you see these large gaps between earnings expectations and multiple compression, that's an opportunity. That's where you see opportunity. And that's why you had the massive relief rally. I mean, the weaker companies today bounced. Like, for example, home builders bounced hard today. That's great. The earnings profile on homebuilders is bad. It's not good. And so it's like, would I want to go out and buy home builders today? No. It's like, well, they're up 5% today. It's like, that's great. There's a lot of other areas that were up 5% today with really good fundamentals that make sense why they're getting a re-rate because there's been no break in the fundamentals and we're just entering earnings season. So, we're going to get a better read. But, I couldn't agree more that all these things ultimately do trickle down and are going to impact how the companies think about their capex spend, their hiring, their firing, all of that. But ultimately the companies that are best equipped to deal with it have pricing power and those companies that have had multiple compression in this environment are the opportunities for investors today.
Yeah. The only thing I think that's — you've nailed it there. The only thing I would add: huge difference between $100 oil and $150 oil and another huge difference again between 150 and 200. And 200 is imaginable by the way in inflation-adjusted terms. We were 200 in 2008 before that crisis happened. So like if we, you know, I think most of the economists I talk to — the math on this stuff is too hard for me to do — but the economists I talk to say, you know, you can live 120, 130, 140, you get much higher above that then you see the economy's sensitivity to the price of oil at that point, but that's a far way off which is some reason for optimism.
