CITIC Securities: Disagreements and Developments in the Middle East Conflict — Returning to the Starting Line, Decisions to Be Made in April

There is significant divergence in market expectations regarding the trajectory of the Iran conflict and its impact. Behind different judgments are three core issues that currently cannot be verified and for which there are no clear answers: First, after the conflict intensity decreases, to what extent can commercial shipping resume? Second, does the Federal Reserve prioritize inflation indicators or focus more on actual employment conditions? Third, is China facing cost shocks or opportunities from supply chain re-shuffling? These questions may only become clearer by April. Faced with great uncertainty, the market has seen some short-term profit-taking, with previously strong-performing assets recently declining more. Overall, most of the performance-driven and narrative-driven market signals, from the start of the year to now, have returned to a similar baseline. The first three months can be viewed as a market rotation driven by expectations and narrative battles during the spring volatility and cooling period, not the definitive outcome for the whole year. The broader rebound in PPI, price transmission, and corporate profit recovery are the directions with both expectation gaps and room for growth this year, but the decisive factors will be seen in April.

Divergence in Market Expectations Regarding the Iran Conflict and Its Impact

1. “Decreased conflict intensity, timely TACO” vs. “Shipping not yet restored, chemical supply chains not truly reflecting supply disruptions.” The first argument’s logic: Since the war began on February 28, 2026, the US and Israel have carried out ongoing targeted eliminations of key military and political figures in Iran, confirming or highly likely killing at least 22 core officials, including the Supreme Leader, Revolutionary Guard Commander, Chief of Staff, Defense Minister, Intelligence Minister, National Security Council Secretary, and Basij commanders. This indicates a significant blow to Iran’s central command, intelligence, and military-political coordination. This view suggests that subsequent major upheavals are unlikely, and if Trump halts and withdraws promptly, TACO transactions could still proceed. The second argument’s logic: Iran’s conflict is highly unpredictable; unless shipping volumes return to normal, marginal trading changes could be disrupted by new shocks at any time. Currently, shipping through the Strait of Hormuz remains low—by March 19, 2026, the number of oil tankers passing per day is still in the low single digits. Additionally, the current spread between Brent crude and Dubai/Oman spot prices is large, possibly due to regional inventory buffers, pricing structure deviations, or policy interventions. If the strait remains closed, prices will ultimately tend toward Middle Eastern spot prices.

2. “Clear risk of stagflation and tightening liquidity” vs. “AI’s impact on employment is greater, making tightening difficult.” The first argument: Historical experience with major Middle East conflicts and supply chain shocks suggests that even if stagflation does not develop, cost-push inflation could delay Fed rate hikes, challenging liquidity conditions. After the March 18 Fed meeting, implied rate cuts in the Chicago Mercantile Exchange data remain at 0-1 times this year. The second argument: AI infrastructure investments will continue, and post-conflict, countries will push for electrification and energy supply chain security (e.g., recent UK easing wind power component tariffs). Overall industrial demand remains strong, and the probability of global stagnation is low. However, AI agents as powerful productivity tools are already impacting employment—February marked a critical point for coding agents, but the full employment impact is still unclear. Large firms’ layoffs are increasing. These factors make Fed policy balancing more difficult. As a data-driven central bank, the Fed likely remains cautious, avoiding clear guidance.

3. “Prolonged conflict would significantly impact China” vs. “China’s supply chain resilience is strong, and oil dependency has decreased noticeably.” The first argument’s logic: China’s high reliance on oil imports, especially from the Middle East—about 36% of total oil imports in 2025—means ongoing conflict would greatly impact energy costs, whereas the US is largely self-sufficient in oil and resources. The second argument’s logic: Looking at the oil import-to-GDP ratio, China’s dependence has decreased from 2.2% fifteen years ago to 1.7% (around $80/bbl for Brent in 2010 and 2024). Current domestic inventories, including strategic reserves, can cover over 90 days of consumption. Energy substitution options like coal chemical and green alcohol routes still have excess capacity, and renewable energy absorption has room to replace some oil demand. China has long-term energy diversification and security strategies, with additional supply capacity from Russia, the Americas, Africa, and Central Asia estimated at 130 million tons/year, plus potential domestic production increases and strategic reserves, totaling about 180 million tons/year—covering the Strait of Hormuz risk exposure of 185 million tons/year. A more likely scenario: disruptions in European, Japanese, and Indian supply chains could shift demand toward China, accelerating the alleviation of China’s overcapacity in chemical and energy sectors, similar to post-pandemic supply chain reallocation.

Three Core Unverifiable Questions Without Clear Answers Yet

1. To what extent can shipping resume after conflict intensity decreases? As of March 19, only five ships are passing through the Strait of Hormuz daily (four small bulk carriers and one refined oil tanker), with no signs of large-scale resumption (pre-conflict daily average 120–140 ships). The blockade has lasted 20 days, with about 20,000 seafarers stranded on Persian Gulf vessels. Current shipping shows significant “camping” features, with only certain ship registries permitted to pass under specific mechanisms. According to LSEG, VLCC (Very Large Crude Carriers) daily charter rates have surged from $10–20/ton to $60–80/ton, sometimes exceeding $90/ton, reaching historical peaks. Lloyd’s reports Iran has established a “security corridor” within its waters, implementing a conditional paid passage system—compliant ships must report owner info, cargo destination, and accept Iranian verification; some operators have paid $2 million for passage rights. Recently, over 70% of ships passing through the strait are from China, Russia, and Iran, with the rest from Panama, Tanzania, Singapore, and other neutral countries; no ships from the US, Israel, or European nations are currently passing.

2. Does the Fed prioritize inflation indicators or employment data? The Fed’s March 2026 meeting kept rates steady at 3.50–3.75%, maintaining a hawkish stance as expected. Powell’s “wait and see” approach indicates uncertainty about the scale and duration of shocks, noting that traditional views often “look through” energy shocks. Currently, TIPS implied inflation expectations for five years have only risen about 23 basis points; considering liquidity impacts, five-year inflation expectations are nearly unchanged. The employment market is also softening—February non-farm payrolls showed negative growth, and December 2025 and January 2026 data were significantly revised downward. The Fed’s latest SEP removed references to “signs of stable unemployment,” reflecting concerns about ongoing employment weakness. The emergence of advanced coding agents like Opus 4.6 and GPT 5.3 Codex in early February signals potential employment impacts, but the full extent remains unclear. Increasing layoffs among large firms suggest the Fed faces a complex balancing act. Given these factors, the Fed likely remains cautious, avoiding firm guidance.

3. Is China facing cost shocks or opportunities from supply chain re-shuffling? High-frequency data show initial transmission of spot and futures prices. Logically, supply shocks should boost profit margins in key segments, especially since China’s supply chains remain resilient. However, globally, the core issue is “high prices, low volume”—not the timing of position adjustments. Downstream manufacturers, before volatility subsides, tend to hold off on restocking to avoid buying at high prices. As inventories deplete, they are likely waiting for the conflict to stabilize and for commodity volatility to decline. Market pricing of industry profits reflects post-stability spot prices, explaining divergence between stock and futures markets. Before volatility decreases, the market is driven by narratives and liquidity shocks, not frequent price signals or long-term expectations.

Short-term Market Adjustments and Recent Declines in Overperformers

Since March, the structure of declines and relative holdings among institutions are mismatched. The top four sectors heavily held by institutions have fallen an average of 5.6% since March, with electric power and communications sectors posting positive returns, while the sectors with the lowest institutional allocation have fallen an average of 8.9%. This suggests that the main downward pressure is from absolute return funds reducing positions, not from sector rotation. In terms of style, low-valuation stocks are safer, while high-valuation stocks have fallen more sharply. At the individual stock level, those with higher gains in the past two months have experienced larger declines—similar to absolute return fund behavior. With valuations high, profit margins not yet fully realized, and macro uncertainties rising, it’s reasonable for absolute return funds to reduce holdings. Currently, fundamentals are giving way to liquidity and narrative factors; stocks that surged on narratives in January–February are experiencing more intense corrections in March. This is normal, and there’s no need to overinterpret price movements.

Back to the Starting Line: Key Decisions in April

1. Core uncertainties about the impact of the Middle East conflict will gradually be clarified after April. The key market questions will see answers emerge in April. Until then, markets remain in a narrative battle, reflecting liquidity withdrawal—US Treasury yields have risen sharply, with the 10-year yield climbing from 3.97% at the end of February to 4.39%, the highest since August last year. Globally, as risk sentiment recedes, countries are strengthening energy and resource security and accelerating electrification. China’s manufacturing competitiveness in pricing and profit margins is just beginning to shift. From a trading perspective, rising prices and PPI rebound are ongoing signals. The main concern is whether upstream prices can transmit downstream; currently, midstream and upstream are raising prices, while downstream remains cautious and inventory-digesting. Only over time, as commodity volatility declines, will downstream procurement normalize. Whether downstream can maintain price increases, sustain profit margins, and convert market share into pricing power remains to be seen. Until then, investors should remain patient, calmly handle price fluctuations, and recognize that April–May will be the decisive period. Even if early-year narrative-driven sector rotations do not lock in gains, it’s not a major issue—active equity funds’ median returns for the year have already returned to about 0.7%.

2. Maintain a strategic focus on China’s manufacturing pricing power. The current core holdings should be in industries with a competitive advantage in market share, high barriers to overseas capacity reallocation, and supply flexibility influenced by policy—namely new energy, chemicals, electrical equipment, and non-ferrous metals. Recent liquidity shocks have made valuations attractive again, similar to the post-April 7, last year, when offshore stocks experienced a significant expectation gap and undervaluation. Building on this, it’s advisable to increase exposure to low-valuation factors, especially insurance, securities firms, and power. From a short-term cyclical perspective, rising prices remain the “sharpest sword,” and PPI trading is increasingly likely to be the main theme for the year. Key opportunities include: 1) chemical products with alternative raw materials or processes under oil price shocks (China’s “coal content” in these products is often higher than overseas competitors), 2) supply disruptions in historically large Middle Eastern and Western European capacities, which could create supply-demand gaps and price increases, 3) products affected by costs that are driven up by substitution demand, and 4) commodities already in an upward price channel, where cost increases provide a window for price hikes amid tight supply-demand balances.

Risk Factors

• Escalation of US-China technology, trade, and financial frictions
• Domestic policy intensity, implementation, or economic recovery falling short
• Unexpected tightening of macro liquidity globally and domestically
• Further escalation of conflicts in Russia-Ukraine, Middle East, and other regions
• China’s real estate inventory digestion falling short of expectations

(Source: CITIC Securities)