Why markets are looking through Middle East risk - EUROPE SAYS
The U. S. -Israel war on Iran began on February 28. Oil prices surged toward $120 a barrel. The Strait of Hormuz, through which nearly a third of the world’s maritime crude passes, was effectively closed. The. . .
The U. S. -Israel war on Iran began on February 28. Oil prices surged toward $120 a barrel. The Strait of Hormuz, through which nearly a third of the world’s maritime crude passes, was effectively closed. The S&P 500 fell 8% over the following month. Then it recovered everything and more. It has since closed at an all-time high, roughly 11% above its March low. Global equities have followed. Markets are not ignoring the conflict. They are looking through it. The question worth asking is why and whether that judgement is sound. The world is far less vulnerable to energy shocks than it wasWhen Russia invaded Ukraine, European inflation was at 6% and rising. Prior to the current conflict, it was 1. 7% and falling, with major central banks already cutting rates. The macroeconomic starting point is fundamentally different. Oil prices were on average 30% lower in 2025 than at the 2022 peak, reflecting abundant supply before the latest tensions emerged. Energy intensity of GDP has declined significantly across developed economies. Governments retain the ability to draw on strategic reserves and provide targeted support. The transmission from geopolitical shock to economic damage is considerably weaker than it was three years ago. A structural investment cycle is doing what energy shocks once preventedThe more important offset has been investment. AI-related capital expenditure contributed more to U. S. growth last year than consumer spending. Hyperscalers and technology companies continue to invest aggressively across chips, semiconductor equipment, networking, memory and power infrastructure. Critically, this cycle is not funded by future expectations. It is funded by strong cash flow and healthy balance sheets, a structural distinction from previous speculative technology cycles that makes current spending trends more durable. The transition from generative to agentic AI only deepens this. Agentic systems require approximately one million times more compute than original conversational AI. Physical AI, robotics, automation, sensors, advanced manufacturing, is emerging as the next major capital, creating a new set of investment beneficiaries. Multiple bottlenecks across hardware, power and networking continue to support pricing power and volume growth across the ecosystem. The global profit pool has evolved in ways that change the calculusWhile prices for several critical AI components have increased far more rapidly than energy prices, much of the hardware stack powering AI is supplied by strategic allies, Japan, South Korea and Taiwan, who play critical roles across leading-edge semiconductors, semiconductor equipment, machine tools and advanced manufacturing. These economies are significant energy importers, but the export surpluses generated by AI-related demand more than offset the drag from higher energy costs. The United States may dominate the software layer. The hardware layer is a shared strategic asset among allies, and it is generating returns that geopolitical tensions are not erasing. Current market valuations in the United States continue to be supported by strong earnings growth from AI-related companies, many of which benefit from dominant market positions, strong balance sheets and cash flow generation. While the S&P 500 is trading at roughly 21–22x forward earnings versus a trailing ten-year average of 19. 7x, investors remain comfortable because earnings expectations are rising faster than stock prices. In fact, the S&P 500 forward P/E has declined from around 22. 2x at the end of 2025 to approximately 21. 4x despite a strong market rally, reflecting improving earnings fundamentals rather than pure multiple expansion. The risks worth monitoringA prolonged disruption to energy markets that pushes costs materially higher and weakens demand would eventually threaten growth through higher costs, weaker confidence and deteriorating earnings. The AI capital expenditure cycle will also turn at some point. History is instructive. Railroads, telecom infrastructure and the internet all experienced phases where investment ran ahead of demand. AI may ultimately follow a similar path. The question is not whether a correction comes but whether the structural demand that follows justifies the infrastructure being built today. Geopolitics is the base case, not just a tail risk like the pastGeopolitical instability is also paradoxically reinforcing several of the most durable long-duration investment themes. Cybersecurity, defence technology, energy infrastructure and supply-chain resilience all become more valuable in a fragmented world. Energy security has become national security. The world is shifting from the cheapest energy source toward the most secure energy source, and that shift is reshaping trade routes, LNG infrastructure, grid investment and the economics of renewables and nuclear simultaneously. Middle East developments have acted more as a volatility amplifier than a fundamental derailment. The global economy entered this period with healthier balance sheets, lower energy intensity, multiple growth drivers and an unprecedented wave of investment in AI, infrastructure and industrial capacity. Geopolitics is no longer a tail risk. It is the base case. The question for investors is whether the structural forces driving the cycle are large enough to absorb it. On current evidence, they are.