US Stock Market "Preventive Decline" Behind the Scenes: Stagflation Concerns Loom Over Market, When Will TACO Arrive?

Southern Finance, 21st Century Business Herald Reporter Wu Bin Reports

At the start of the Middle East conflict, investors were quite optimistic, expecting the conflict to end quickly.

But the deadlock has lasted much longer than market expectations, and the historic supply disruption caused by the Strait of Hormuz blockade is short-term or unsolvable. According to CCTV News, Iran’s newly appointed Supreme Leader, Muqtada al-Husayni Khamenei, issued his first statement on March 12 via national television, stating that Iran will continue to adopt strategic measures, including blocking the Strait of Hormuz, and will open new fronts if necessary.

On March 12, the International Energy Agency (IEA) stated in its monthly report that the Middle East conflict is causing the largest supply disruption in the history of the global oil market, affecting about 7.5% of global oil supply, with even greater impact on exports.

Transport through the Strait of Hormuz has plummeted. The IEA cited data showing that last year, about 20 million barrels per day of crude oil and refined products were transported through the strait, but current throughput has dropped by over 90%. Rising oil prices, flight cancellations, and economic uncertainty are also weakening oil demand.

As crude oil prices surge again, breaking above $100 per barrel, concerns about inflation intensify, leading investors to sell stocks. On March 12, U.S. Eastern Time, all three major U.S. stock indices fell more than 1.5%, with a broad sell-off sweeping the market. Except for the energy sector and some defensive stocks, most sectors declined significantly.

Short-term panic will eventually subside, and only assets with resilient cash flows, pricing power, and narrative resonance will stand on a new footing after revaluation.

U.S. Stock Market “Preemptive Decline”

Since the escalation of the U.S.-Iran conflict, U.S. stocks haven’t fallen much. Recently, as the situation has reached a deadlock, the market has entered a “sell-off mode.”

Li Huihui, a management practice professor at Lyon Business School in France, analyzed to 21st Century Business Herald that the U.S. stock market’s return to “sell-off mode” is a typical “preventive decline.” Wall Street’s current pricing models are still based on an optimistic assumption: supply chain disruptions are only short-term tactical frictions, and the strong commodity prices are only temporary. Therefore, the overall decline isn’t too deep yet. But this is the biggest risk: if the blockade of the Strait of Hormuz becomes a “new normal,” the entire capital market will need to undergo a severe “reassessment” of inflation expectations and asset valuations.

Now, investors must seriously consider longer-lasting and deeper energy supply shocks, which could reignite inflation while suppressing economic growth.

What funds truly fear now isn’t just rising prices but stagflation. Li Huihui predicts that if crude oil prices substantively stabilize at $100 per barrel, every $10 increase could push U.S. CPI up by 0.2 to 0.3 percentage points, and the annualized real GDP growth rate could be dragged down by 0.15 to 0.2 percentage points. On one hand, inflation is hard to contain; on the other, the economy risks stalling—this is the most deadly poison.

Gama Asset Management Global Macro Portfolio Manager Rajeev de Mello said investors need to increase the probability assessment of the worst-case scenario, which is a stagflation-type shock.

The short-term market outlook is not optimistic; alarms are far from being lifted. Li Huihui warned that if the “blockade” is extended by another week, U.S. stocks could fall another 5% to 8%, especially in sectors like industrials, consumer discretionary, airlines, transportation, and banking, which are most sensitive to costs, credit, and interest rates, and will face even greater pressure than the index itself.

Before the situation becomes clearer, Tokio Marine Asset Management Fund Manager Hironori Akizawa said he is increasing cash holdings because if the Middle East crisis persists for a long time, the probability of recession or stagflation will inevitably rise.

When Will TACO Arrive?

In the context of a midterm election year, the U.S. may find it difficult to sustain large-scale military actions against Iran for long.

Li Huihui analyzed that the most sensitive issues now are not the battlefield itself but U.S. domestic gasoline prices, inflation expectations, and public support for “why we fight.” Currently, President Trump’s bottom line mainly involves two things: the Dow Jones Industrial Average and gas station prices. In just two weeks, U.S. gasoline prices have risen nearly 60 cents per gallon. If crude prices stay above $100 per barrel, the national average gasoline price could approach the political red line of $4 per gallon. High oil prices will squeeze consumers’ disposable income, causing significant voter shifts in swing states for the Republican Party.

Regarding the future development of the Middle East conflict, Li Huihui believes the most likely scenario is not a full escalation or immediate ceasefire but a deadlock of “high-pressure deterrence + limited strikes + negotiations warming.” Trump needs to maintain a “tough” narrative and cannot surrender immediately; however, he also cannot bear the consequences of prolonged blockade of the Strait of Hormuz, high oil prices, and continued Fed rate cuts. The White House is likely to shift its goal from “expanding military achievements” to “controlling spillover, restoring shipping, and creating room for negotiations.”

As for when Trump might retreat again (TACO), Li Huihui estimates the window is within the next 2 to 6 weeks. But TACO does not mean Trump will suddenly withdraw completely; rather, he will begin to tighten his stance: reduce rhetoric about expanding conflict, avoid ground wars, accept third-party mediation, and promote local ceasefires or shipping channel reopenings. Unlike tariffs, which can be rolled back with a tweet, disruptions to oil and gas supply, soaring shipping insurance, and infrastructure damage cannot be immediately fixed with words.

Ryan Detrick, Chief Market Strategist at Carson Group, said the market has already realized that the resolution of the Middle East conflict could be further delayed. The current market sentiment is to sell first and consider fundamentals later. Apart from the energy sector, almost no other sectors are truly safe.

However, historical experience shows that the long-term impact of geopolitical conflicts on U.S. stocks is often limited.

Li Huihui noted that historical data is clear: the impact of war usually causes a V-shaped dip in the first two to three weeks but does not interrupt the upward cycle of U.S. stocks. The tricky part this time is that the geopolitical conflict directly involves the Fed’s balance sheet. Due to the secondary effects of rising oil prices on core inflation, Li Huihui has also lowered her forecast for Fed rate cuts this year: from three cuts to two, with the first cut delayed from June to September or even Q4. In the long run, U.S. stocks still have recovery potential, but the rebound will be slower, more like a repair rally after earnings and interest rates realign, rather than a quick V-shaped recovery.

Regarding entry timing, Li Huihui suggests paying attention to three signals: first, oil—not just futures prices during trading but whether shipping through the Strait of Hormuz improves and if oil prices can stabilize below $90; second, bonds—especially whether the 2-year U.S. Treasury yield stops rising and if the 10-year yield stabilizes; third, earnings expectations—if there is a systemic downward revision, especially in industrials, airlines, and consumer discretionary, and if banks, software, and advertising also begin to be widely downgraded, indicating the shock has not yet fully passed.

Ignoring Noise, Focus on Long-Term

Disregarding the noise of geopolitical conflicts, in the medium to long term, investors should focus more on fundamentals.

Despite short-term market weakness, Wall Street remains optimistic about the long-term performance of U.S. stocks. Goldman Sachs’ trading division noted that hedge fund short positions in the U.S. stock market have reached a nearly three-and-a-half-year high. If positive news about ending the Middle East conflict emerges, it could trigger a large-scale short covering and drive a surge in U.S. stocks.

According to Li Changfeng, Head of Market Strategy at Invesco, one of the long-term advantages of U.S. stocks is their “soft power,” meaning many high-quality software companies with light capital, high profitability, and stable business models. Recently, market narratives have begun to shift. If AI agents continue to advance, could they eventually replace the services provided by these companies? This might lead to significant differentiation within the tech industry: “AI replacing humans” versus “potential substitutes” could diverge sharply; leading chip, memory, and other hardware stocks in emerging markets have soared, while U.S. enterprise software companies have continued to decline, with valuation-to-revenue ratios even retreating to extreme levels. However, AI adopters with high pricing power are expected to see continuous improvement in net profit margins, and the disruptive impact of AI on the software industry still needs time to verify.

Long-term, Li Changfeng remains optimistic that AI will bring major changes to corporate business models and even consumer lifestyles, creating many investment opportunities. Given that AI themes have already risen significantly since 2023, a more cautious approach is to select individual stocks from the bottom up, identifying potential beneficiaries and those likely to be impacted, rather than blindly chasing the theme.

As the AI wave enters a new stage, Li Huihui believes the focus is no longer on “whose model is stronger” but on “who can turn AI’s capital expenditure and computing power demand into sustainable revenue.” The first phase of AI has mainly focused on large models and training chips. But this year, investment themes are shifting toward three main directions: first, power and data center infrastructure, as the bottleneck for AI is increasingly not algorithms but electricity, networks, cooling, and access; the U.S. grid and power generation capacity have been forced to expand; second, semiconductor equipment, HBM, advanced packaging, and interconnects—while not all chips are worth pursuing, equipment and storage have more certainty; third, enterprise software and vertical applications—though there will be differentiation, the real opportunities lie in companies that control proprietary data, deeply embed into customer processes, and can deliver compliant solutions.

Looking ahead, Li Huihui believes that in the medium to long term, assets supported by actual cash flows—such as high-capital, low-elimination-rate assets (HALO)—are more advantageous than broad growth stocks. She is particularly optimistic about energy, public utilities/electricity infrastructure, and military defense assets.

Specifically, Li Huihui notes that as long as oil prices stay high, the most immediate improvement in cash flow and profitability will come from upstream and oil service chains. This time, the market is not just trading a one-time conflict but is pricing in higher energy risk premiums. Public utilities, once considered low-elasticity sectors, now have a different logic: the core incremental growth comes from data centers.