Markets Struggle As Iranian Conflict Continues

Equity sectors face continued risk-off sentiment, with the exception of energy. Over the weekend, the conflict escalated further as the U.S. and Israel carried out more strikes

against Iran. After market hours on Friday, the U.S. hit Kharg Island, a key oil production & export hub for Iran. No immediate ceasefire talks were signaled on Saturday as President Trump suggested more strikes on Iran if ships traveling through the Strait of Hormuz were threatened. Finally, yesterday the White House signaled a coalition of countries would secure the Strait from further disruptions. It's helpful to keep in mind that with spike in oil, equity markets have suffered less downside (-5%), so far, than the decline following Liberation Day last year (-19%).

Some positive news last week came from the economic data. Inflation appeared to be rather tame last month. The Consumer Price Index came in as expected (+0.3%) for

the month of February and was flat year-over-year. In addition, the PCE Price Index, which the Fed leans on for inflationary data, also came in as expected (+0.3%) and actually declined year-over-year. However, given the current spike in oil, the good news on inflation is likely short-lived. For every $10 per barrel increase in oil, inflation could increase between 0.2 and 0.4%. The average price for gas in the U.S. has increased from $2.93/gallon at the end of February to $3.70/gallon as of Friday. That's a 26% increase over the past two weeks, which would likely move March's CPI reading up to at least 3.0% on a year-over-year basis. This concern has basically taken rate cuts from the Fed off the table until the 2nd half of the year. Any kind of ceasefire in the Middle East could mean an inflation spike in March would be temporary.

The issues in Private Credit continue to haunt markets for the time being. There has been a spike in default rates for private credit, with the most recent reading for February

putting default rates at 5.8%, according to Morningstar DBRS. The Private Credit market is down more than 17% since the January 15th peak. Some private credit issuers, such as Apollo, KKR, Blackstone and others are down more than 20% over that same time period. However, we're not seeing those troubles bleed over in to public credit yet. The spreads between high yield corporate bonds and government bonds have not moved higher as in prior recessionary periods. In fact, spreads haven't even moved as high as last year's response to Liberation Day, which saw spreads rise 74%.

Private Credit issues have caused some to compare the current situation to Subprime Lending that led to the 2008 Financial Crisis. However, a brief analysis could help put

the two situations in perspective. During the Subprime Lending crisis, the real estate market was the primary culprit, which involved more than 10 million jobs between construction, mortgage lending, and financing. In fact, more than 5.9 million jobs were lost in the 2008 Financial Crisis. It is estimated that only 2 million to 3 million jobs are represented by the current private credit industry. To further contrast the situation, the real estate market in 2007 was a $22-25 trillion market. Most estimates put the U.S. private credit market value at around $1.3 trillion. Finally, the 2008 Financial Crisis saw both equities and home prices decline by at least 30% or more. So far, we have not seen losses in private credit bleed over to that degree in equities. Markets appear to be applauding the coalition in the Strait of Hormuz this morning as oil futures are muted and equities are higher. Expect more volatility in markets until a ceasefire can be achieved.

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