Goldman Sachs sees 2 markets diverge on Iran war risks

Global equity markets are showing a surprising resilience to the US naval blockade of Iran, with the S&P 500 recovering all of its pre-conflict losses, as investors begin to price out the worst-case military scenarios, according to a top Goldman Sachs strategist.

"The market has made a judgment that the path of negotiations allows you to take some weight off those really bad military outcomes," Dominic Wilson, a senior markets advisor at Goldman Sachs, said on the firm's 'Exchanges' podcast on April 14. "You have to be very mindful of the risk scenarios and you have to be very clear-eyed about how the things you own will perform in that worst-case scenario."

The rally in stocks contrasts sharply with the interest rate market, which remains positioned for a more hawkish response from central banks concerned about inflation from higher energy prices. Brent crude has hovered above $100 a barrel, up from around $70 before the war, pushing US gasoline prices up more than 38% to over $4.12 a gallon.

This divergence suggests that while equity investors are looking past the immediate conflict, which began after US-Iran talks failed, the bond market is bracing for stickier inflation that could keep central banks from cutting rates. Wilson warns that as markets relax, this tail risk of a wider conflict appears underpriced, creating a vulnerable backdrop for investors who are not adequately hedged.

Equities Rally While Rates Price in Hawkish Fed

Wilson explained that the stock market's recovery is rooted in a reassessment of extreme negative outcomes. While the US blockade of the Strait of Hormuz, which began April 13, has halted most oil tanker traffic and drawn threats from Tehran, markets are betting the situation will ultimately be resolved within weeks, not months.

"For an asset that has a very long discounting horizon, you can look through a short-term period of economic damage," Wilson said. "What really hurts equities is a lack of confidence about what the other side of the problem looks like."

This forward-looking nature of equities stands in stark contrast to the interest rate market. Wilson notes that rate markets are pricing in a higher probability of central banks remaining on hold or even tightening policy to combat the inflationary shock from the conflict. He believes this may be an overreaction.

"The paths where rates end up lower than where the market is priced are more numerous than the paths where they end up higher," Wilson argued, suggesting the market's overall pricing is still too hawkish.

Dollar Finds Support, but AI Theme Returns

The conflict has provided short-term support for the US dollar, benefiting from both safe-haven flows and the country's status as a major oil exporter. The dollar's trade-weighted index has erased nearly all its year-to-date losses. However, Wilson believes the medium-term structural arguments for dollar weakness—including a high valuation and the Federal Reserve being more likely to cut rates than other central banks—remain intact.

Meanwhile, despite the geopolitical turmoil, the market's pre-war themes are making a swift comeback. "The AI theme has come back very, very quickly, not just in conversation, but in terms of the way the market is actually moving," Wilson observed. He pointed to semiconductor stocks, such as Nvidia, which have not only recovered but in some cases hit new highs, while software stocks continue to face pressure.

For investors navigating this complex environment, Wilson recommends a dual-track strategy: maintaining selective long positions in favored themes like AI, cyclical commodities, and strong pre-conflict markets like Japan and Korea, while actively hedging against a severe downturn.

"This is a moment to be adding to deeper downside hedges in equity and credit," Wilson advised. "I wouldn't be re-engaging with risk unless you are also adding to your protection at the same time."

This article is for informational purposes only and does not constitute investment advice.