Stock Market Rally Likely in Mid April

The stock market is normally weak in March after the bulk of earnings season is over.  After earnings season, there is a dearth of information from companies, so the news flow is dominated by short sellers, random acts such as war or negative political developments.  This March is obviously particularly problematic with the Iranian war disrupting the oil market, fear mongering about private credit and numerous bear theses associated with AI.   

We estimate that the worst-case scenario for the oil market is an indefinite closure of the Strait of Hormuz resulting in oil prices rising to $140/barrel and that the equilibrium price of oil absent war threats being approximately $60/barrel.  Given that the worst-case scenario is extremely unlikely given the entire world ex Iran and Russia is intent on opening the Straight, we expect oil prices to trade in the middle of the range of potential prices in the area of $100.  We expect that the Straight of Hormuz will be opened, possibly involving US ground troops,  within a month and oil will trade below $70/barrel. 

We also believe that losses in the private credit markets in the absolute worst case will be 10% comprised of an unprecedented 15% default rate and a very low recovery rate of 33%.  During the Great Financial Crisis the peak default rate was approximately 10% for high yield bonds and private credit.   We do not expect banks or the high yield market to sustain significant losses as those sectors have very limited exposure to the buyout credit market where most losses are occurring.  A 10% loss rate would imply that the market has, as usual, massively overreacted to the increase in private credit defaults by selling BDCs, alternative asset managers and some financials down by over 30%, which implies an over reaction by at least 20% given the most draconian potential loss rate of 10%.

We also believe that the Ai short theses are both inconsistent and overstated.  Specifically, the theory that cloud service companies will get inadequate returns on their cap ex, yet every software business and other many other businesses will be supplanted by AI are inconsistent.  We forecast that cloud service companies will achieve excess returns on investment as every business recognizes both the opportunity of AI and the competitive risk.  There will be software companies whose business models are disrupted by AI but many enterprise level software companies, such as Oracle, will benefit as they assist clients to implement AI while continuing to maintain their mission critical software systems.

The reality of these short theses regarding both AI and private credit will remain uncertain until we get real information from companies during 1^st quarter earnings season in Mid-April.  In addition, we should get clarity on the reopening of the Straight of Hormuz by mid-April.  Finally, the stock market is often weak going into tax payment season on April 15^th.   Consequently, we expect a power rally in Mid-April as we enter the seasonally strong April earnings season.  In the interim, we expect the stock market to be volatile but with good support in the 6,600 range for S&P 500 Index as US economic fundamentals are strong.  We reiterate our 8,000 year-end target on the S&P 500 Index with 3 Fed rates still likely after oil prices decline.