Markets Celebrate Failure
The Credit Strategist Blog
None of the goals of the Iran war have been achieved yet markets are trading as though the war is over and America won. No doubt we have inflicted serious harm on Iran but Iran has not abandoned its nuclear ambitions, lost all of its ballistic missiles capabilities, or ended its influence over the Straits of Hormuz. It still retains meaningful ability to cause trouble and do damage to Western interests. The U.S. needs to do more to achieve its goals.
Equally, none of the non-war issues that drove stock prices sharply lower are resolved. The war isn’t over. Inflation isn’t lower (in fact it’s higher). Energy prices are off their highs but likely to remain elevated for a sustained period of time (possibly the rest of 2026), contributing to higher-than-expected (or hoped) inflation for the rest of 2026. Even Treasury Secretary Scott Bessent now agrees the Fed can/should wait to lower interest rates with the prospect of inflation dimming in the fog of war. The “AI eats software” trade that roughly halved software P/Es, concerns that much of the announced data center builds are vaporware, and fears that a great deal of the money spent on AI will never see a return on investment also remain.
None of these issues is resolved yet the market has regained its pre-war losses. And private credit has yet to produce any good news, just assurances that it won’t destroy the economy all at once (just company by company along with its private equity twins). I agree that private equity doesn’t pose a systemic risk (in the sense that mortgages posed one in 2008), but the long-term damage caused by leveraging up Corporate America over the last few decades has inflicted serious long-term systemic damage that must be acknowledged. And high levels of redemptions from private equity vehicles are likely to continue for the remainder of 2026 which could limit capital available for these companies to make loans and finance transactions (a good thing, but banks could fill the gap, a bad thing).
But the fact that none of these problems have been solved seems to matter. And - just to beat a dead horse for a moment - nobody (NOBODY) is talking about the federal deficit that will hit $40 trillion by October/November and sits out there like the iceberg waiting for the Titanic. The annual deficit is around $2 trillion and the annual interest cost of servicing the deficit is over $1 trillion and both numbers are rising and unsustainable. I fear that all the stock market gains being realized are going to vaporize in a bond market rout when Treasury buyers demand a reasonable return for loaning money to the U.S. government. Right now, in my opinion, they are willing to lend money to the government at a negative real rate (not a consensus view). Treasuries are still considered “safe” but their nominal return is seriously diminished by the real-world rate of inflation which is much higher than official government inflation statistics.
I don’t know how much further this rally will run. The markets was oversold from a technical standpoint before the rally started; now it is at its most overbought level since October (or was a couple of days ago). Software stocks are leading the way though nothing has changed with respect to the threat posed to them by AI, but nobody really had a handle on that threat in the first place. The best reason to sell those stocks is that their valuations were stretched; now they are much lower so it looks safe (to some) to stick their toes back in the water. PE stocks are up about 20% despite absolutely no redemption relief and no sign that their software loans are in better shape than a few weeks ago. In short, the rally is liquidity and momentum-driven which is another way of saying it is due to a shift in psychology that ignores the same conditions that set off the sell-off. If you want to call it market schizophrenia be my guest. To me that’s as solid an explanation as anything else. You sure can’t convince me this is driven by fundamentals or facts.