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The Surprising Strength of Equity Markets
One of the most striking features of the current market environment is how resilient equities have remained despite significant geopolitical upheaval in the Middle East. With the conflict involving Iran disrupting oil flows and rattling global energy markets, one might expect a far more pronounced pullback in stocks. Yet the market has largely held its ground, buoyed by persistent buy-the-dip mentality and investors who, crucially, have not panicked.
This resilience is surprising, but it also carries a lesson: abandoning a long-term investment strategy in response to short-term volatility is almost always a mistake. Trying to time the market by moving to the sidelines is a recipe for disaster. The better approach is to stay true to one's risk tolerance and ride out the turbulence — while keeping a sharp eye on where the genuine growth opportunities are.
Oil and the Strait of Hormuz: The Central Risk
The dominant concern right now is oil. While Iran itself accounts for only about 3 to 5 percent of global oil output — with roughly 90% of that going to China — the real issue is the Strait of Hormuz. Prior to the conflict, 20% of the world's oil supply flowed through that strait. With that passage now disrupted, the longer the situation persists, the more upward pressure builds on oil prices.
Higher oil prices slow the economy, weigh on consumer spending, and eventually erode investor sentiment. The base case scenario suggests this disruption lasts four to five weeks before tankers begin moving through the strait again. The broader conflict may persist well beyond that, but the resumption of oil flows should provide meaningful relief to energy markets and, by extension, to equities.
Defense Stocks: Following the Money
Even before the current conflict, aerospace and defense was one of the strongest growth themes in the market. The escalation has only reinforced that trend, making several defense names compelling investments.
L3Harris Technologies (LHX) has been a standout, up over 20% year to date. Trading at roughly 30 times forward earnings with a 1.3% dividend yield, L3Harris is deeply involved in missile defense systems — the interceptors being deployed against Iranian counterattacks, and the technology that would underpin any effort to build a domestic Iron Dome-style missile defense system. There is still a reasonable entry point here.
Huntington Ingalls Industries (HII), the designer and builder of nuclear-powered submarines, has similarly outperformed the S&P 500, also gaining more than 20% on the year. Trading at a more modest 24 to 25 times forward earnings with a comparable dividend yield, Huntington made headlines recently when, for the first time since World War II, a U.S. submarine sank an adversary ship. That kind of capability keeps order books full.
Kratos Defense & Security Solutions (KTOS), up about 17% year to date, represents the cutting edge of autonomous aircraft and drone technologies. Kratos was one of the first movers in the drone space and is actively supporting current operations by using drone technology to identify missile strike targets. Drones are no longer the wave of the future — they are the wave of the present. And as drone usage proliferates on all sides of modern conflicts, the need for drone countermeasures opens up yet another layer of opportunity.
Beyond Defense: AI, Power, and Biotech
Defense is not the only growth theme worth watching. AI infrastructure spending continues to accelerate and is likely to remain a dominant investment theme for the balance of the decade. The insatiable demand for power — whether from natural gas, oil, clean energy, or nuclear — is another secular trend that transcends the current geopolitical moment. And on the biotech front, a pickup in mergers and acquisitions activity is creating fresh opportunities for investors willing to look beyond the daily headlines.
This is, as many predicted at the start of the year, a stock picker's market. The winners are those who follow the money into sectors with genuine structural tailwinds, rather than chasing broad index returns.
The Fed's Impossible Position
The macroeconomic backdrop complicates matters further. Rising oil prices are set to push headline CPI and PCE higher, even though core measures — which strip out food and energy — may remain more subdued. The Federal Reserve is acutely aware of this dynamic heading into its next meeting.
The problem is that the Fed is caught between a rock and a hard place. A weak labor market argues for rate cuts to support the economy, but surging energy-driven inflation argues against easing. The result is likely paralysis: no action from the Fed for at least the first half of the year.
The incoming Federal Reserve chair is widely expected to be more dovish, but there are reasons for skepticism. A strong historical commitment to reducing the size of the Fed's balance sheet suggests the new leadership may focus more on the long end of the yield curve than on aggressively cutting short-term rates. With only two more rate cuts needed to reach the neutral rate of 3%, the market may get those cuts in the second half of the year — but investors should not expect much more than that, assuming the economy holds steady and inflation, absent the oil shock, continues to moderate.
Navigating Volatility Ahead
The VIX hovering around 26 signals elevated but not extreme volatility. More bouts of turbulence are likely throughout the year, driven not just by the Middle East conflict but also by midterm elections, debt ceiling debates, ongoing government shutdowns, and the myriad uncertainties that come with a politically charged environment.
Yet beneath the surface noise, the fundamental growth opportunities remain intact. The key is to stay invested, stay disciplined, and look past the headlines to the structural trends — in defense, AI, energy, and biotech — that will define the next several years of market performance. There will be more volatility, but there is also ample opportunity for both growth and income for those willing to look for it.