It has been our experience over the years that stock pickers can sometimes be reluctant to bake in macro concerns until their companies start to openly worry about them. With this in mind, we spent some time last week reading through what companies in the Russell 3000 and S&P 1500 have been saying in March about the conflict in the Middle East on their earnings calls and in sell-side industry conference presentations around the Street.
In terms of the bigger picture, companies have been describing the war as fluid and evolving with the duration of the military conflict and the closure of the Strait of Hormuz in focus. While a few companies noted the possibility that higher oil could spark a recession or an economic downturn/disruption, others emphasized that they or their customers are used to volatility or highlighted their ability to manage through. Several noted they were closely monitoring the situation and running scenarios and stress tests. One company provided some helpful framing for how to think about impact. They organized it in “four tiers” in terms of how quickly they would feel the impact: direct exposure in the region, freight shipping availability, cost and inflation including raw materials, and demand. This was a good reminder that it will likely take time for impacts to filter through.
In outlook discussions, many companies noted that it was early days or too soon to tell what the impacts will be. A few alluded to the idea that there was some conservatism in their guidance due in part to the conflict, but others expressed confidence in guidance unless there was a major escalation. Optimistic comments around manageability seemed tied to the idea that the conflict will be of shorter duration. Several companies referenced the idea of passing through higher costs, having some amount of inventory on hand (one company mentioned 6 months), or the idea that impacts would not be seen until the latter part of the year. A few openly discussed hedging. Many noted that their direct exposure to the region was minimal. The outlook commentary we read left us thinking companies have had good reasons for staying calm, and that any risk to earnings likely lies more in 2nd-half numbers.
On demand, several noted they had not seen material impacts yet, while a few noted their expectation for near-term headwinds. Some thought that demand might get pulled forward in the short-term due to 2nd-half/supply chain concerns. Other companies noted defense-related products, ammo, and drones/counter drones might be expected to see a demand boost. One company also highlighted that longer term, the rebuilding of infrastructure could boost demand.
“Companies have been providing investors with additional reasons at the company level to see the US as relatively insulated.”
Lori Calvasina, Head of U.S. Equity Strategy, RBC Capital Markets
On the consumer, one company noted that the strength at the top in the K-shaped economy was a positive as that cohort tended to be more immune to these kinds of events. On the topic of what level of gas prices would be a pain point or cause demand destruction, one company pointed to $4/gallon while another pointed to $5/gallon. Hotel/travel companies noted that they had seen cancellations within the Middle East region but that it had not rippled out, though some acknowledged that could change in the future especially given the sensitivity of airfares to the conflict. We've been underweight the Consumer Discretionary sector and market weight the Consumer Staples sector this year, and what we read last week keeps us on the sidelines for both sectors for now. We'd be more open to Staples as a rebound play on conflict resolution given better valuations.
Impacts to supply chains accounted for a considerable amount of the discussion. Transportation and freight costs and the rerouting of shipments were in focus. In addition to oil and natural gas, resin, fertilizer, aluminum, and helium were referenced. Some companies noted they would draw on past experience to manage. Several noted they hadn't seen major impacts yet. Surcharges and extended lead times were mentioned as well. The good news here is that companies have become accustomed over the past decade to managing through supply-chain problems. But the bad news is that this issue is clearly taking up much of the C-suite headspace at the moment, which could delay other initiatives.
Zooming out, in our client conversations we've been highlighting how improved valuations in the US relative to non-US developed markets generally opened the door for the US to act as a safe-haven trade, and how our analyst survey on the war's impacts supported the idea that the US equity market should be seen as having some fundamental buffers. What we read in transcripts from the past two weeks confirms to us that companies have been providing investors with additional reasons at the company level to see the US as relatively insulated, and we think that that reassurance has also contributed to the resiliency of the US equity market.
But what we read last week also indicates to us that if adverse and significant impacts are coming, particularly from an extended or escalated conflict, it will simply take additional time for companies to understand what those are and communicate them to investors. What we read also suggests to us that companies tend to believe a shorter-duration conflict can be managed through, but there are many open questions if it goes on too long.
Our base case has been that the S&P 500 would experience a tier-one “garden variety” drawdown of 5-10% this year, which could take the index a bit below 6,300 at the lower end of that range. We have also noted that risks of a tier-2 “growth scare” drawdown of 14-20% have risen. The five growth scares that the S&P 500 has experienced since the GFC have ranged in duration from 2 months to 9 months. What we read last week makes us think that if we are in the middle of a growth-scare drawdown now, it may not be a quick, two-month one like the tariff episode of 2025 since it may simply take some time for the equity community to fully gauge earnings impacts.
