Insight & Outlook: Fidelity Market Signals Weekly

Progress with U.S.-Iran pact, against persistent headwinds

The newly signed agreement between the U.S. and Iran was the first step in opening the crucial Strait of Hormuz, and could pave the way for a permanent negotiated peace deal in the next 60 days. While many outstanding questions remain, the deal comes as the risk of an energy shock reaches a new crescendo, amid signs of widespread strain for Main Street consumers on everyday items like food, housing, paychecks, and savings.

U.S. petroleum reserves have reached their lowest level since 1983, at 340 million barrels.^* The energy shock risk has come back into the forefront of investor concerns with higher oil prices, along with expectations of rising interest rate and inflation, and lower growth and P/E multiples. At current withdrawal rates, U.S. reserves could hit “tank bottom” in mid-September, which would result in rationing and other worst-case scenarios—certainly a motivation for U.S. negotiators to finalize a deal.

At the same time, Main Street consumers have felt the pinch since the start of the U.S.-Iran conflict three months ago. They are experiencing erosion in the job market, negative real wage growth, sticky higher inflation, and savings at a multi-decade low. With uncertainty likely to continue, portfolio construction and asset allocation have remained key to navigating volatility.

Household health, a critical factor for the economy

Consumer spending (Personal Consumption Expenditures) constitutes approximately 68% of U.S. nominal GDP—making household health the single most important variable in any GDP forecast. Q1 GDP was recently revised lower from 2% to 1.6%,¹ largely due to weaker consumption.

May payrolls show low quality of employment

The May Payroll Report at the headline level exceeded expectations across both Establishment and Household surveys, but beneath the surface the quality of job creation was poor, with 79,000 full-time jobs lost and 266,000 part-time jobs created. Job creation primarily came from the hospitality, local government and health care sectors.

Negative real wage growth straining the consumer

Real (after inflation) average hourly earnings fell precipitously in May, primarily due to the magnitude and duration of the energy dislocation caused by the U.S.-Iran conflict. Nominal wages fell slightly from 3.6% in April to 3.4% in May (YoY), but the Consumer Price Index (CPI) rose in the same time period from 3.8% to 4.2%, an energy-fueled hit to consumer spending power (Exhibit 1).

The U.S. naval blockade in April, which limited oil tanker traffic through the Strait, led to the rapid and significant drain in global oil and petroleum product inventories. The drop in strategic reserves and price increases renewed concerns that the U.S. stockpile would hit “tank bottoms,” which could result in a worst-case scenario of oil rationing via higher prices and demand destruction. At present withdrawal rates, U.S. reserves could hit tank bottom, estimated to be around 150 million to 250 million barrels, in mid-September, depending on factors such as hurricanes or shifting global export levels. The U.S. today is a major oil producer (at 13.3 million to 13.7 million barrels per day) but is also the largest oil consumer, at 20 million barrels per day.

Energy driving higher inflation

The CPI’s 0.5% increase from April to May (MoM) was its highest level since April 2023. Energy was the primary driver, with the CPI’s energy index rising 3.9% in May after rising 3.8% in April, accounting for approximately 60% of the monthly all-items increase. Energy increases over time get transmitted through to the economy via freight costs, airline fares, food distribution, utilities, and higher inflation expectations—all of which typically sets the tone for sticky inflation over the medium term.

The core measure of inflation (excluding the volatile food and energy segments) also rose to 2.9% on a YoY basis, showing growing passthrough impacts on services and shelter costs.

Savings rates hit multi-decade low

With real wage growth going negative, consumers have been forced to dip into savings, with the savings rate falling to a multi-decade low of 2.6% in April (the latest available data as of this writing). To put the absolute value and the drop into context, the long-term average rate has been 8.4% since 1960 and only a year ago was at 5.5%, as outlined in Exhibit 2. Credit card and automobile 90+ day delinquencies rose to record levels at the end of the first quarter—even surpassing the levels during the Global Financial Crisis, according to a recent report from the Federal Reserve Bank of New York.²

Other signs of caution for global trade

Recent global trade data suggests signs of stockpiling, business pricing increases, supply chain disruptions, and rising commodity prices as a result of the conflict. For example, the S&P Global US Manufacturing Purchasing Managers Index (PMI) surged in May, the sharpest upturn since April 2022.³ But S&P Global’s economist, Chris Williamson, noted that if one looked under the hood, it was primarily driven by precautionary stockpiling as firms bought inventory ahead of more expected price increases and supply chain disruptions.

The Producer Price Index rose from 5.7% in April to 6.5% in May on an unadjusted, YoY basis,⁴ indicating that consumer inflation has further to rise. It was the largest 12-month rise since November 2022.

The World Bank’s Global Supply Chain Stress Index, illustrating supply chain disruptions, has also risen to levels not seen since the height of the Covid-19 pandemic.⁵ Based on the above factors, S&P Global estimates U.S. real GDP growth for the second quarter to decline to slightly above 1%.

While investors are primarily focused on the energy market, one commodity, sulfur, has been hit particularly hard and could have a ripple effect throughout the economy. Approximately 50% of seaborne global sulfur supplies pass through the strait, and there is little evidence to suggest that any supplies have made their way through since the U.S.-Iran conflict began on February 28. A consequence is that sulfur prices have skyrocketed by 250% since the beginning of the conflict and 320% on a YoY basis. Sulfur, which gets converted to sulfuric acid is a key ingredient in the refining of non-ferrous metals, especially copper, and in phosphate-based fertilizers.

Moreover, copper—a critical metal used in the AI infrastructure buildout, electric vehicles and renewable energy—has come under pressure by the Strait’s closure. Any disruption in the global copper trade acts as a bottleneck, delaying and raising the cost of goods and projects.

Investment implications

Conflicts by nature create uncertainty, and may result in regular bouts of volatility as new information gets priced in by the market. Main Street consumers in particular have felt the pinch of the ongoing conflict across many major economic barometers affecting jobs, wages, energy costs, and more.

One effective way to navigate such uncertainty is to maintain a diversified portfolio with minimal tilts across asset classes. We would also recommend conservative investors hold some volatility smoothing assets with a focus on income generation.

Given that U.S. GDP growth is primarily being driven by hyperscaler spending on AI infrastructure, investors may also want to consider assets that may be key beneficiaries of this spending, such as select mid- and small-cap cyclicals. (For more, please see, From AI’s next act: from digital intelligence to real-world economic impact.)

Inflation risk stemming from uncertainty about the resolution of the conflict could also be hedged via short-duration, credit-intensive fixed income assets, as well as commodity producers on the equity side. Portfolio construction and asset allocation will certainly remain key factors in navigating these choppy and uncertain waters.

The S&P Global US Manufacturing PMI^® is compiled by S&P Global from responses to questionnaires sent to purchasing managers in a panel of around 600 manufacturers. The panel is stratified by detailed sector and company workforce size, based on contributions to GDP. Data collection began in May 2007.

^*Per barrel energy data from the U.S. Energy Information Administration. www.eia.gov