Original Author: Long Yue

Original Source: Wall Street Insight

It has been over a month since the outbreak of the conflict in the Middle East, yet the US stock market has rebounded.

Recently, Wall Street has been selectively "filtering out the noise." The S&P 500 index has increased nearly 10% since March 27, and the Nasdaq 100 has risen approximately 12% during the same period, marking 10 consecutive trading days of gains — the longest streak for this index since 2021.

More critically, the S&P 500 has completely erased all losses since the Iran war in trading this Monday.

"The Market Has Declared Victory"

Rich Privorotky, head of Goldman Sachs' Delta One trading desk, pointed out: "The market seems to have declared itself victorious in the 'war' with Iran, even though the conflict itself has not truly ended."

While some believe that Iran is merely waiting for the right moment, Privorotky is surprised by Iran's current response: "The Houthis have not taken any escalatory actions in the Red Sea region, drone attacks have not increased, and the ceasefire agreement has not been broken." He believes that declaring victory now may be premature, but the stock market clearly interprets the situation as having stabilized.

Goldman Sachs strategist Chris Hussey bluntly stated: "It has been over a month since the outbreak of the Iran war, and it is unbelievable that the S&P 500 has risen by 1.6% year-to-date, which was unimaginable just last week. Despite the fluctuations on the road to ultimate peace, stocks are forward-looking instruments, and as we have noted before, the market cannot afford to wait for a situation they know will eventually be resolved -- this dynamic can explain today's market behavior and the reasons for the regained strong performance."

The logic of the market is shifting. Doug Peta, chief US investment strategist at BCA Research, stated: "The stock market, as well as the entire financial market, seems to be less concerned about the situation in the Strait of Hormuz."

In the overnight market, leading companies in the field of artificial intelligence are also emerging. The Mag 7 continues to perform robustly, rising by 3%, with a cumulative increase of 15% over the last 10 trading days (nine of the ten trading days saw gains).

The semiconductor sector has been a key driving force behind this rebound. Bloomberg data indicates that earnings expectations for the semiconductor sector jumped about 10% within three trading days, significantly pulling up the overall EPS forecast for the S&P 500. Goldman Sachs data shows that Nvidia and Micron are expected to contribute over 50% of the EPS growth for the S&P 500 this quarter.

And this rebound is not just a stock story.

US Treasury yields dropped as oil prices fell, declining approximately 3 to 4 basis points across the board. Bitcoin broke through $76,000, reaching a new high since the outbreak of the conflict. Gold traded above $4,800, marking the highest level since March 18. The US dollar continues to weaken, nearly erasing all gains since the outbreak of the war.

Market liquidity is also returning to normal. Goldman Sachs data shows that the top-of-book liquidity for S&P 500 constituents has rebounded from about $3.5 million during the peak of geopolitical uncertainty to $13.16 million, an increase of 141% compared to the 20-day average. The proportion of ETF trading volume in total market trading volume has also fallen from about 50% at peak to 29%.

Interestingly, a "familiar script" from Trump seems to be playing out again...

Funds "Chasing Upward," Short Sellers Forced to Cover

Regarding this strong rebound in the US stock market, a seasoned stock trader remarked: "The flow of funds is one-directional... CTA, clients, everyone has underweighted their risk exposure, and now they are all chasing upward."

This "panic buying" is backed by multiple forces:

Institutional investors are leading the rebound. Mark Hackett, chief market strategist at Nationwide, noted that after large-scale sell-offs, institutional attention has turned back to fundamentals, which are supportive.

CTA funds are buying heavily, but long-only funds and hedge funds are selling. According to Goldman Sachs trading desk data, long-only funds (LO) had slight net sell-offs, while hedge funds (HF) recorded a 3% net sell, mainly reducing their positions in information technology, industrials, and communication services — they are selling to absorb the buy orders from CTAs.

Short covering is accelerating. Goldman Sachs' rolling short basket has seen three significant surges, with non-profitable tech stocks soaring, and the most shorted stocks facing a short squeeze.

Goldman Sachs attributes the sustained strength of the "Mag 7" to four factors: improvement in geopolitical background leading to the unwinding of index hedging positions (the Mag 7 accounts for about 33% of S&P 500 weight), the easing of funds repositioning trades since Q1, the market's early positioning for strong earnings season expectations, and ongoing stock repurchase plans supporting the market.

In Earnings Season, Fundamentals Are Being Repriced

The shift in market narrative is supported by data.

This week, major financial institutions such as JPMorgan, Citigroup, Wells Fargo, and BlackRock are sequentially releasing first-quarter earnings reports. Chris Hussey from Goldman Sachs pointed out that the banking sector is typically viewed as a barometer of the overall health of the US economy, "the earnings reports this morning show that despite market concerns about inflation, AI, private credit, and consumer spending, the situations for households and businesses remain solid."

Inflation data also provides support. PPI increased by 0.5% month-over-month in March, below expectations. However, RBC Capital Markets interest rate strategist Blake Gwinn warned, "the market is increasingly interpreting PPI data through the lens of PCE," leaning towards "viewing weak data as a lagging indicator, believing that inflation pressures are still on the way."

The Stock Market "Looks Ahead," While the Oil Market is Still Waiting

It is notable that there is a clear divergence between the stock market and the oil market.

WTI crude oil futures fell below $91 on the day, and Polymarket data shows that the probability of WTI falling below $90 by the end of the month is rapidly increasing. The direct trigger for the drop in oil prices is: reports suggest that Iran is considering suspending some oil exports to promote negotiations, and that both the US and Iran are discussing a second round of peace talks.

Market data — the crude oil forward curve (represented by December Brent futures) indicates that the crude oil market believes the resolution to supply disruptions will take longer — contrasting with the stock market's optimistic sentiment of "mission accomplished."

Chris Hussey from Goldman Sachs explains this: "Stocks are forward-looking instruments, and the market cannot afford to wait for a situation they know will ultimately be resolved — this dynamic can explain today's market behavior and the reasons for the regained strong performance."

After the Rebound, Risks Remain

Despite a noticeable improvement in market sentiment, several strategists remain cautious about the outlook.

Lori Calvasina from RBC Capital Markets warns that the uncertainty of war and its ripple effects still pose a high risk of a "growth panic pullback." In a client report on Sunday, she wrote: "If the fundamental narrative around the war or its impacts changes, the stock market still has room to decline from a valuation perspective, potentially even deeper than before."

Mark Hackett from Nationwide is skeptical about whether the S&P 500 can break historical highs: "I doubt we can truly break the historical peak before tangible progress is made in negotiations. But once that day arrives, conservative positions, strong fundamentals, and reset expectations will create a long-compressed spring force."

Bond investors also remain skeptical about the good news regarding inflation. Raghav Datla, a global market interest rate strategist at Citigroup, stated: "In future reports, it will be hard to see lower inflation data, and no one can accurately predict what those numbers will be."

Veteran strategist Ed Yardeni is more optimistic. In an investor report on Sunday, he stated that similar to the Russia-Ukraine conflict, financial markets are learning to coexist with the Iran war and are sticking to their judgments — the S&P 500 hit its bottom on March 30.

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