The BlackRock Investment Institute has noted that despite the effective closure of the Strait of Hormuz and the resulting disruptions to global supply chains, US stocks continue to reach new all-time highs. A common view is that the market has become disconnected from reality, as oil prices, commodity prices, and bond yields rise while equity and credit markets remain resilient. The Institute argues that there is no contradiction here. AI infrastructure development is offsetting the growth drag from supply shocks, while energy market pricing still reflects expectations that the strait will eventually reopen. Rising inflation and bond yields are identified as key risks to maintaining a risk-on stance. Since the onset of the Middle East conflict, emerging markets and US equities, buoyed by strong AI-related earnings, have led global markets. Countries more exposed to supply shocks have lagged, while regions tied to the AI boom, such as South Korea and Taiwan, have outperformed. Sector trends show a similar pattern, with AI-related industries driving investment returns higher, while sectors more vulnerable to inflation, such as materials, have underperformed. Policy expectations are also evolving in the same direction. As inflationary pressures build, markets now anticipate approximately three interest rate hikes in Europe, while expecting US rates to remain unchanged. Meanwhile, US credit spreads are below pre-conflict levels, suggesting markets do not anticipate severe economic damage. Conclusion: These movements indicate that current market pricing reflects robust corporate earnings and the impact of supply shocks to date. The BlackRock Institute believes that US stocks hitting record highs is not disconnected from elevated oil prices, commodity prices, and bond yields. Current pricing simultaneously reflects AI-driven growth and the effects of Middle East supply shocks. Therefore, the Institute maintains a risk-on stance. The resilience of US equities reflects the scale and breadth of AI infrastructure build-out. First-quarter earnings growth expectations for the S&P 500 have risen to approximately 28%, about double the level from early April, while earnings growth expectations for the MSCI Emerging Markets technology sector have climbed to around 160%. An AI-driven cybersecurity "arms race" is emerging, supporting demand for computing power, cloud infrastructure, and advanced models, further reinforcing earnings momentum. Related data is striking: quarterly earnings for the "Magnificent Seven" tech giants are projected to grow by 57% (Nvidia has not yet reported), triple the Bloomberg estimate from last month; capital expenditures for the year are expected to reach as high as $725 billion, an increase of about 10% from pre-earnings release levels. Currently, the effect of AI infrastructure development is outweighing the typical impact of macro shocks, which usually drag on growth and earnings and depress stock performance. This makes interest rates the key transmission mechanism through which supply shocks affect risk assets. Rising energy prices and input costs are exacerbating already elevated inflation, an effect more pronounced in Europe due to greater exposure. Simultaneously, AI development is increasing demand for capital—not only in technological infrastructure but also in energy security and broader infrastructure rebuilding amid geopolitical fragmentation. Capital previously flowing to the US is increasingly being diverted to these areas, intensifying funding competition and putting upward pressure on long-term bond yields. The equity market is balancing growth against interest rates: as long as earnings growth remains sufficiently strong, it can offset the impact of rising yields, as seen in the AI-driven stock rally since the launch of ChatGPT. The risk is that if supply disruptions persist, the combined effect of higher inflation and increased capital demand could push yields high enough to pressure valuations. BlackRock currently maintains a risk-on stance, with an overweight view on US and emerging market equities, which benefit from AI development and commodity exports. The Institute prefers equities over bonds and continues to hold an underweight view on long-term US Treasuries, favoring short- and intermediate-duration bonds for yield. This stance assumes the Strait of Hormuz will eventually normalize, although there are no signs of reopening yet. A prolonged closure of the strait could alter the current landscape. It would drive inflation and interest rates higher, thereby pressuring valuations and tightening financial conditions, ultimately posing challenges for risk assets and the pace of AI development.
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