A Surprising Reordering of Market Drivers
In an environment that, on the surface, looks like a classic energy shock, something counterintuitive has been happening beneath the headlines: artificial intelligence is mattering far more to markets and the broader economy than oil. While oil prices and geopolitical headlines continue to grab attention and occasionally push markets around, the real force lifting equities over the past several weeks has not been crude. It has been AI.
The most recent earnings season made this unmistakable. What can fairly be described as a blowout, bullish reporting cycle was driven almost entirely by AI — appearing in top-line revenue, bottom-line profits, and, perhaps most importantly, through expanding margins. When investors look at what equity markets are actually responding to, the answer keeps coming back to AI rather than to barrels of crude. It sounds strange given the macro backdrop, but it is the truth of recent price action.
The Oil Story That Did Not Materialize
Before hostilities began, the analyst class was loudly warning about extreme scenarios. If the Strait of Hormuz were to close for any meaningful stretch of time, the forecasts were dire: $200 oil, $250 oil, even calls for $300 from certain corners of the market. Those numbers never came close to materializing.
This raises a real question. Were the forecasters simply wrong, or are we merely in a delayed phase — quietly drawing down stockpiles while the genuine pain still lies ahead? Honesty requires admitting uncertainty here. It seems likely that there was a degree of hyperbole in those analyst projections and that the damage will not be as severe as the worst calls suggested. But the possibility that they are right cannot be dismissed. If the disruption truly lingers and we end up confronting $200 or $250 oil, the impact will be qualitatively different from a $100 environment.
That uncertainty has shifted the appropriate posture from forecasting to reacting. Trying to predict the next move in this conflict has been a losing exercise — anyone who tried got it badly wrong. A read-and-react approach is the only sensible one in conditions this fluid.
The Bond Market's Quieter Warning
For weeks there has been a meaningful disconnect — not so much between credit and equities, but between rate markets and equity markets. The Treasury market has been signaling something that the equity market, in its enthusiasm, was largely brushing aside: that we may be stuck in a higher-for-longer interest rate regime for some time.
That message finally began to register late last week and into early this week. With the 10-year yield sitting around 4.56%, the equity market's modest weakness in recent sessions has been directly attributable to rates, not to oil or geopolitics. Equities effectively woke up to the recognition that they may have to deal with elevated yields longer than they had hoped — particularly if this conflict turns out to be an eight- to ten-week affair rather than the four- or five-week event many initially priced in.
Higher rates are a headwind for equity multiples and, by extension, equity prices. That lesson was taught harshly in 2022, even though today's setup differs materially from that period. The practical implication is straightforward: meaningfully higher equity prices will be difficult to achieve unless the 10-year yield can move back below 4.5%.
Repositioning for an AI-Led, Rate-Sensitive Environment
The investment implications of this regime are concrete. Heading into the conflict, the dominant theme had been the so-called broadening trade — leaning into small caps, midcaps, and the parts of the market that had been left behind by mega cap tech. That posture was not anti-AI; it was a bet that a combination of stimulus-driven tailwinds would broaden GDP growth and deliver a nominal kick across a wider swath of the market.
The war has effectively put that thesis on hold. The right response has been to rotate back into the mega cap names that have been driving the market. Being short AI, or even underweight AI, is not a viable stance for the next several years. AI will be the driver, and portfolios need to reflect that reality.
Internationally, opportunities remain — but selectively. Asia and Latin America stand out. Latin America in particular offers a clever angle on the broadening-out trade because of its embedded commodity exposure. If the conflict drags on and commodity prices remain elevated for an extended period, Latin American economies stand to benefit from that backdrop in a way other regions cannot.
The current pillars of a sensible allocation look something like this: pull back from US small and midcaps where the broadening thesis is on pause, lean into Latin American and Asian exposure abroad, and return to the mega cap growth trade at home. That trio offers participation in the AI thesis, a commodity hedge if the geopolitical situation deteriorates, and exposure to the international economies most likely to benefit from the shifting global picture.
The Takeaway
The dominant narrative of the moment — energy shock, geopolitical crisis, oil-driven markets — does not match what the price action is actually showing. AI is moving stocks. Rates are constraining how high they can go. Oil, for all the headline drama, has not delivered the catastrophe many predicted. Recognizing this hierarchy of drivers, and positioning accordingly, is what separates a productive response to the current environment from one anchored to the wrong story.