The Big Picture

Briefing.com Summary:

*Market sentiment has soured since the start of the war with Iran.

*Earnings estimates have continued to increase, but doubts are surfacing about the achievability of those estimates.

*The market is nearing some red lines that create an opportunity to leg into beaten-down stocks and sectors.

Through February 28, the stock market was looking pretty good. Granted, most of the mega-cap cohort was languishing, but the broader market seemed to be benefiting at their expense, fueled by confidence in the economic, earnings growth, and interest rate outlooks.

One day and one month, though, has made things look and feel differently. On February 28, the U.S. and Israel jointly launched a military campaign against Iran under the pretense of preventing Iran from getting a nuclear weapon, destroying its ballistic missile-making capabilities, and triggering regime change.

The ensuing market response has not been good. The major indices have rolled over; oil prices have skyrocketed 47%; the 2-yr note yield has spiked 53 basis points; the 10-yr note yield has jumped 46 basis points; and expectations for another rate cut this year have been swept away.

Simply put, the fog of war has clouded the stock market's rose-colored outlook.

Takes Two to Tango

With oil prices rising due to shipping disruptions through the Strait of Hormuz, inflation concerns have increased. That is the genesis of why Treasury yields have risen and why market participants no longer expect a rate cut this year. In fact, the fed funds futures market has assigned a 37% probability to a 25-basis-point hike at the December FOMC meeting, according to the CME FedWatch Tool.

A rate hike in 2026 wasn't on anyone's bingo card when the year began, so it goes to show how quickly this geopolitical conflagration has changed the dynamic.

The latter point notwithstanding, the stock market is still harboring hope that the Iran war can end soon and that oil, fertilizer, and other goods can start flowing freely again through the Strait of Hormuz. The main hangup at the moment is that there is no clear sense that Iran harbors the same hope.

It bears repeating that it takes only one party to start a war, but both parties to end it. On that note, just because the U.S. declares the war is over doesn't mean Iran will consider the war over. That is why the context and the participation around any such declaration are key for the market's direction of travel.

For now, things are going south in terms of stock prices and bond prices, but not all things are going south. Remarkably, earnings estimates have continued to rise.

On February 27, the forward twelve-month earnings estimate for the S&P 500 was $317.82. Today it is $329.02. With the S&P 500 down 7% in the interim, the result has been multiple compression. The forward 12-month P/E multiple has slipped from 21.7 to 19.7, a slight premium to its 10-year average. For the equal-weighted S&P 500, the forward twelve-month P/E multiple has gone from 17.6 to 15.9, which is a 5% discount to its 10-yr average.

Things have gotten less expensive, but of course, things have also gotten a lot more uncertain and have created misgivings about the achievability of earnings estimates. 

Picking Spots

Although the U.S. and Israel started the war with Iran, the reverberations of what is going on are not isolated. They are having far-reaching effects around the globe, with markets in Europe and Asia feeling the pinch of shipping disruptions more acutely than the U.S., since they are highly dependent on energy imports.

The energy price shock for them, then, has a higher voltage than it does for the U.S. Nonetheless, the interconnected global economy is at risk of seeing a slowdown in spending driven by supply chain disruptions that are leading to higher prices for consumers and businesses alike.

Central banks are all grappling with whether to raise rates to combat the inflation pressure. That understanding has driven up sovereign bond yields and has led to flatter yield curves and less conviction in the outlook. Hence, the willingness to buy complacently on any dip has been supplanted by more discernment related to the achievability of earnings estimates.

Market participants are no longer chasing stocks higher. Rather, they are picking spots to average down in an environment where phrases like "stagflation," "recession," "rate hikes," and "tighter financial conditions" are a credible part of the market narrative that is also featuring talk of private credit concerns and AI disruption. 

They have a lot of spots from which to choose. Every S&P 500 sector is down since the war began, with losses ranging from 3.2% to 11.5%. The lone exception is the well-situated energy sector (+12.5%). The major indices have fallen between 8% and 12% from their 52-week highs. Only 22% of S&P 500 stocks are above their 50-day moving average, while only 44% are above their 200-day moving average.

The S&P 500 itself is trading below its 200-day moving average (6,635).

Briefing.com Analyst Insight

The stock market has gone from looking supremely confident to looking inordinately shaky. That could change in a hurry if, and when, the U.S., Israel, and Iran are all on the same ceasefire page, and the hope is that concession comes sooner rather than later.

In The Big Picture column we posted on March 5, we identified some red lines that we think President Trump wouldn't want to see markets cross with velocity. They were $100.00/bbl oil, a 4-handle on the national average for gasoline prices (we're at $3.98 now, according to AAA), a 4.50% 10-yr note yield, and an S&P 500 that trades below 6,300. The latter would mark a 10% correction from the 52-week high.

We are close in each respect, so it is our expectation that the Trump put will be exercised in some fashion when those lines are crossed. Again, though, for the sentiment tide to turn, there has to be conviction in the belief that Iran is done being at war with the U.S. and Israel as much as the U.S. and Israel are done being at war with Iran and its proxies.

That understanding and when it is no longer in doubt are equally important. The longer the war drags on, the longer the energy price shock and supply chain disruptions will persist and upend global economic activity and lofty earnings estimates.

With the S&P 500 nearing a 10% correction and some other important red lines coming into focus, there is an opportunity to start legging into the market with cash sitting on the sidelines. However, with other issues lurking out there, like the private credit worries, rising mortgage default rates, tariffs, and AI disruption, it is not an "all-in" environment because it is tough to be all-in like before on the achievability of earnings estimates.

--Patrick J. O'Hare, Briefing.com