Goldman Sachs researcher Dominic Wilson argues that the recent resilience in U.S. stocks does not indicate a dismissal of risks. Instead, markets are beginning to price in a scenario of conflict de-escalation. However, with continued instability in Iran, tail risks have not disappeared, and investors must remain vigilant.
On April 14, Wilson discussed the Iran conflict, including the impact of a U.S. blockade of the Strait of Hormuz on global markets, with podcast host Allison Nathan on Goldman Sachs' "Exchanges."
News of a potential Iran ceasefire agreement last week triggered a significant market rally, which was subsequently dampened by the U.S. announcement of a Strait of Hormuz blockade. Despite this, the S&P 500 has recovered all its pre-conflict losses, while oil prices remain elevated.
Wilson stated this market reaction is not surprising. Historically, during crises, markets often begin to recover before on-the-ground conditions improve, a pattern observed during the COVID-19 pandemic and trade tariff shocks.
Wilson pointed out that markets have made their own assessment, judging that the current negotiation landscape allows for reduced concern over the most severe military outcomes. Nevertheless, he believes that while investors are rebuilding core long positions, they must actively establish hedging positions.
Specifically, he suggests focusing on AI-related assets, cyclical and commodity-linked emerging market assets, and markets like Japan and South Korea that were strong performers before the conflict. However, he particularly emphasized:
"You must always be aware of the risk scenario. You must be acutely aware of how your portfolio would perform under a worst-case situation."
Simultaneously, a noticeable divergence has emerged between interest rate markets and equity markets, with the former pricing in a more hawkish stance. Wilson noted that market concerns about inflationary pressures potentially leading central banks to hold rates steady or even tighten policy may have resulted in an over-pricing of hawkish expectations.
The logic behind the equity market rebound is that it has digested extreme risk scenarios.
Wilson explained that the market's recovery stems from a repricing of extreme negative outcomes. In the initial weeks of the conflict, fears included a prolonged deterioration and more aggressive military solutions. With negotiations underway, the market has significantly lowered the perceived probability of these "worst-case scenarios," shifting more weight towards a path leading to resolution.
Using the COVID-19 pandemic as an example, he noted that equity markets bottomed out before infection and mortality rates peaked. He stated:
"For an asset with a long discounting cycle, short-term economic damage is bearable. What truly frightens the market is uncertainty about the future."
As long as the market believes the current tensions will be resolved within weeks, the difference between a two-week or an eight-week standoff is not substantial for the valuation of long-duration assets.
However, Wilson stressed that this assessment does not mean downside risks have been eliminated: "Extreme risks still exist. We cannot confidently say that the scenarios we previously feared won't resurface. As markets become complacent, tail risks start to look underpriced."
Interest rate markets may have over-priced hawkish central bank expectations.
The trajectory of interest rate markets contrasts sharply with equities. Wilson observed that since the conflict began, rate markets have consistently been more concerned about hawkish central bank responses. Goldman Sachs metrics suggest the market has largely priced in expected mid-term growth impairment, but the perception that central banks will remain cautious persists.
He attributes this partly to path dependency from recent high inflation. The "scarring" from that period has made markets more alert to central bank reactions. Additionally, pre-conflict market pricing, which anticipated two and a half Fed rate cuts this year, was overly dovish, making some correction reasonable.
However, based on Goldman's probability distribution of forecast scenarios, Wilson believes: "There are more paths where rates end up lower than current market pricing suggests, than paths where they are higher. Overall, market pricing remains skewed hawkish."
He added that the probability of rate hikes is higher in Europe than the U.S., but even so, the most likely course for most central banks is to hold steady, not actively tighten.
Short-term dollar support has strengthened, but the medium-term weakening thesis remains intact.
Wilson stated that the supportive effect of an oil price shock on the U.S. dollar aligns with historical patterns. The dollar benefits from safe-haven inflows and improved terms of trade due to the U.S.'s status as a petroleum exporter. The trade-weighted dollar is now only slightly weaker than at the start of the year, having largely reversed its earlier 2024 decline.
He believes this conflict has reminded the market: "Holding dollars is an effective hedge against certain shocks, rather than a reason to reduce dollar exposure to avoid risk." This has made some investors more cautious about betting on dollar weakness. However, Wilson emphasized that the structural logic for medium-term dollar weakness remains unchanged.
Dollar valuation is still expensive, the Fed is still more likely to cut rates relative to other major central banks, and the geopolitical and institutional factors previously driving capital away from the U.S. have not fundamentally reversed. He said: "In the short term, this event has provided the dollar with more support than expected. But medium-term, the story of dollar weakness likely still holds."
The AI theme is强势回归, requiring a strategy that balances offense and defense.
Although geopolitical conflict remains the primary focus for investors, the trends that previously dominated markets have not vanished, and capital is flowing back rapidly. Wilson noted: "The AI theme is not just being discussed; it is rapidly returning in market action."
Wilson observed that semiconductor stocks have not only recovered pre-conflict losses but some have reached new highs, while software stocks continue to face pressure. He emphasized that institutional investors are very reluctant to abandon their core holdings; once markets stabilize, capital quickly returns to AI areas they value.
Facing ongoing uncertainty, Wilson advises investors to maintain a dual-track strategy of "selective longs + active hedging." He believes that when markets rise on negotiation progress and sentiment relaxes, it is an opportune time to add tail risk hedges. Conversely, when markets fall on new negative news, it presents a chance to add core risk exposure at lower prices.
Specifically, when markets decline and hedges perform, one can increase exposure to structurally favored assets like tech stocks, cyclical commodities, and emerging markets (e.g., Japan, South Korea) at lower prices. When markets rally and relax, one should immediately increase protection against downside risk.
Wilson said: "Do not leave yourself unprotected against deep tail risks. I would not advise increasing risk exposure if you are not simultaneously increasing protection."
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