The single biggest overhang hanging over the stock market and its rally in recent weeks has been the conflict involving Iran. With both governments now confirming that a framework peace deal is in place, that dark cloud appears to be lifting — and markets are reflecting the shift substantially this morning. The core question is how meaningful this development truly is, and whether investors are getting ahead of themselves after having "priced in peace" several times before.
Trusting the Signals Until They Change
The guiding principle here is simple: you have to trust the signals until they change. A telling early signal emerged a couple of weeks ago, during the height of the conflict. Even with all the tension, oil never managed to push above $100 a barrel. That restraint told us something important — the oil market itself believed we were close to the end of the conflict. Of course, anything can change, and volatility should be expected right up until the signatures are actually signed. But the overall direction is the right one.
The most impressive aspect of the current picture, when you look out across the rest of the year, is how far oil has already come down. If conditions keep progressing, prices could reach the low $70s by the end of the week.
Why the Iran Conflict Was the Market's "Dark Cloud"
The reason this conflict represented the biggest dark cloud over the market was the inflationary pressure it threatened to impose in the back half of the year. Higher oil meant higher inflation, and higher inflation meant the threat of tighter policy. With the conflict hopefully now resolved, that calculus flips.
If oil plummets and gas and diesel prices fall substantially over the coming weeks as a result of the peace deal, the inflationary threat is taken off the table entirely. That, in turn, allows the conversation to shift away from geopolitical risk and toward the Federal Reserve. Critically, rate hikes can now be taken completely off the table. The setup heading into summer becomes one where economic growth is very strong while inflation is decelerating — a favorable combination. The discussion could even begin turning toward rate cuts sometime toward the end of the year.
Are We Over Our Skis?
Despite the strength of the rally, we do not believe the market is over its skis when we look toward year-end. The expectation is that the market continues to make higher highs. That said, clients have been told to still expect some type of correction over the summer, simply as a function of normal volatility — markets do not go straight up.
There is an important caveat to that correction call. If the Fed comes out on Wednesday with a dovish tone, the summer correction may be much smaller than it would otherwise be, or may not materialize as significantly. It remains a fluid situation. But the through-line is clear: investors who stuck with the market and bought the dips have been handsomely rewarded, and that trend is expected to continue throughout the year.
The Timing and the Fed Under Kevin Warsh
The timing of the peace deal could not be any better, particularly in relation to the Fed's first meeting this week under Kevin Warsh at the helm. Had Warsh been forced to navigate an unresolved conflict and $100 oil, he would have had his work cut out for him — convincing his team and the voting members to look through that inflation would have been a tough sell. With the peace deal in place and hopefully signed by Friday, an enormous amount of pressure is lifted off of him.
Warsh is known as a hawk, largely because of his desire to bring the balance sheet down and keep it in check. So if he strikes a more dovish tone during his press conference, that would be extremely bullish for the market. Of course, it is anyone's guess what he will actually say. Even more important than his words is how the market interprets them. Historically, when a new person takes over as head of the Fed, markets get very choppy as they try to understand the path forward.
The one thing that could derail the rally and prevent new highs would be a hawkish tone in the press conference. But given how far oil has dropped, a more dovish tone seems likely precisely because of the day's news. On many fronts, this is a hugely significant moment.
A Broadening Market
As geopolitical risks rose, the market had begun to narrow into certain favored sectors. With a genuine resolution to the conflict, a broadening out is expected. One of the key dynamics now in play is that the 10-year yield and the long end of the curve are starting to come down. That suggests we may have hit peak rates in the near term within the bond market — which opens up other interest-rate-sensitive areas to catch a bid.
Those areas include homebuilders, small caps, industrials, and financials. To capture this broadening, exposure was recently added in RSP, an equal-weight version of the S&P 500, providing exposure outside of the dominant technology names. Small caps, notably, are making new highs again today.
Technology is still expected to lead, because that is where the beta and the money flows are concentrated. But the good news for investors now is the ability to broaden out while still holding some defensive positions. Healthcare was recently added as one such defensive position — expected to perform well over the next few months. It does not offer the same "juice" as tech, but it helps balance things out on choppy days. Broadening, combined with falling yields and falling oil heading into Fed week, is extremely promising. Even so, investors have learned that in this market you must be ready for anything, prepared for surprises, and nimble enough to act when the market moves violently.
Why Equal-Weight Over Cap-Weighted
The preference for an equal-weight strategy like RSP over the traditional cap-weighted S&P 500 rests on a specific view: the "Magnificent Seven" may actually lag on the tech side. The preference is instead to own the semiconductors. Some S&P 500 exposure has been swapped out for RSP precisely to reduce exposure to the Mag Seven names, and that move complements — from a volatility standpoint — the existing exposure to semiconductors.
So when technology is mentioned here, it specifically means semis. In addition, software has finally started to be bought as well — a genuinely contrarian play that could catch a bid in the second half of the year. The overall positioning, then, is: underweight the Mag Seven, overweight the semis and the software ETFs, and lower exposure to SPY by swapping it for RSP. This combination allows an investor to take advantage of the broadening out while remaining concentrated on the specific corners of the tech side expected to outperform the Mag Seven in the back half of the year.