There are plenty of concerns occupying markets right now:

• Conflict in the Middle East which escalated with weekend strikes on Iran (see our analysis below)
• Continued speculation on the potential for AI to disrupt certain industries and possibly the whole economy
• The Nvidia result revamping debate about over-investment in AI
• Growing unease over private credit

Ahead of Operation Epic Fury, the US market (S&P 500) was off only 0.4% last week and down 0.8% for the month.

It underperformed global equity markets, with the FTSE 100 (+2.1%), Euro STOXX 50 (+0.1%) and TOPIX 500 (+3.4%) all up for the week.

Last year’s two leading sectors – tech and financials – are now lagging in the US, while more capital-intensive stocks are outperforming amid an improving economy and a market reassessment of their relative competitive advantage.

Bond yields fell across the curve last week, helped by a focus on the disruptive effects of AI.

In commodities, lithium surged 23.5% on supply disruption. Copper (+3.5%) and gold (+3.4%) also rose.

Australia experienced a solid week with the S&P/ASX 300 up 1.5%, taking the monthly return to 3.9%.

The final week of ASX reporting season reinforced an earlier trend of reasonably solid performance.

The economic backdrop remains broadly benign, while companies are generally doing a better job in managing expectations and framing their investment case.

The Outlook in Iran

The US/Israeli attack on Iran could prove to be a seminal moment in the geopolitical landscape.

The spectrum of potential outcomes is very wide, with vastly contrasting implications.

From a market perspective the focus – as with the Ukraine conflict – will be on the consequences for supply of key commodities and disruption to the Strait of Hormuz.

Oil is a key consideration with almost a third of the world’s crude shipped through the strait. But 33% of the world’s fertiliser, 32% of methanol and 19% of LNG is also exposed.

Closure of the Strait of Hormuz is a risk.

There have been radio warnings to commercial vessels forbidding transit – though no proclamation from Iran’s Supreme National Security Council.

There were also reports Sunday evening of a US-sanctioned oil tanker – one apparently moving Iranian oil illegally – under attack.

There has already been a material reduction in traffic in the Strait.

However this is a response to the insurance industry which has quickly moved to implement a war-risk premium, cancelling coverage for ships in the region or hiking rates by as much as 50 per cent.

Ships must pause or slow their journeys while this is resolved.

There is a widely-held view that there is unlikely to be material disruption given Iran’s economic reliance on oil exports – and 80 per cent of oil travelling through the Strait is on its way to Iran’s ally, China.

There is also no clear historic precedent for a closure.

Previous threats of closure have not eventuated. During the 1980-88 Iran-Iraq war the strait remained open, even as combatants attacked each other’s tankers.

The other risk is that Iran may seek to destroy oil and gas infrastructure in other Gulf countries, which could disrupt supply.

All that said, this is highly unpredictable situation given the existential threat to the Iranian regime.

Oil was already trading around $US73 – about a $US8 premium – which imputed around a 20% risk to disruption. So a move to 50% risk would take the market to $85 and 75% risk to $105.

The risk to the upside from there would be the duration of any blockage.

Other possibilities to bear in mind include:

1. OPEC+ raising production, with a meeting held Sunday to discuss a production hike. Rumours are of potentially 400k barrels per day (bpd)
2. UAE and Saudi use oil pipelines to bypass the Strait; this may equate to 30-40% of the volumes
3. The US and China access their strategic reserves
4. The US limits oil exports, which may drive a wedge between the price of West Texas Intermediate (WTI) and Brent.

Longer-term, the key issues relate to what happens with the Iranian regime.

The worst-case scenario is some sort of internal conflict or regional separatism breaking out in Iran, which could disrupt its economy and oil production.

A preferred outcome is more akin to Venezuela where a new regime acquiesces to US demands relating to the nuclear program, in return for economic support.

The challenge for markets is an oil-induced shock lowers growth and potentially hampers the ability for the US Fed to cut rates.

Countering this, we know lower fuel prices is an integral part of President Trump’s mid-term campaign – and he will be focused on ensuring the conflict does not derail that objective.

The outlook for AI and software

Fears around the potential for AI to disrupt the software industry and the broader economy seemed to reach a crescendo last week

The antecedents began in January, with three developments at developer Anthropic, which is a leader in the enterprise AI market:

1. New data demonstrated a material improvement in the capability of Anthropic’s Claude Code product, which can do the work of human programmers
2. Anthropic successfully launched Claude Cowork, a user-friendly interface which has broadened the accessibility of AI-driven coding, allowing people without software development skills to use its agentic capability.
3. The January release of 11 specialised Cowork “plug-ins” which allow Claude to perform tasks previously managed on dedicated software products in the sales, finance, legal and marketing industries.

Two events escalated concerns last week: 

1. A widely-circulated article from finance newsletter Citrini speculated about a dystopian future for society. It described a world where AI agents replaced workers, with productivity benefits captured by a narrow group of AI companies. This could lead to a “doom loop” where job losses impacted consumption, leading to 10% unemployment, a private credit meltdown, a mortgage crisis and a stock market drop.
2. E-commerce software maker Block (XYZ) announced it would cut around 4000 staff (about 40% of its workforce) after dramatic improvements in programming productivity. Meanwhile logistics software developer Wisetech (WTC) also announced it would reduce headcount by 20%. Both arguably validated the concerns articulated by the Citrini article.

Investors reacted by extending their AI concerns beyond the software industry to the broader economy and fears of rising unemployment.

There have been some rebuttals to the Citrini piece, notably from hedge fund manager Citadel, highlighting flaws in the essay.

Citadel argues that productivity gains in one part of the economy historically drive activity in other parts. It also enables lower interest rates, which would also stimulate growth.

The Citrini piece may actually have marked the near-term low in the software sector.

Block’s announcement prompted the realisation that software companies may be able to expand their margins as a result of AI.

Nvidia and Anthropic also argue that software is central to the adoption of AI, with agents acting as users of software tools, not replacements.

Finally, the drawdown in the S&P 500 software sector P/E multiple has reached close to the lowest levels seen in 2009 and 2022.

Nvidia

The bellwether’s quarterly earnings were 4% above expectations, but the stock fell 6.7%.

• Revenue grew 73% year/year, with acceleration projected through to mid CY26.
• EPS is projected to grow 50% in CY27.
• An incremental revenue step-up has been sustained at US$10-11billion per quarter, from around $5 billion in 2023-24.

Despite this the stock continues to de-rate – recently down to 21x – which reflects concerns over the sustainability of AI spend.

The latest update on AI capex spend by the hyper-scalers, governments and neoclouds has seen a material step up in 2026 to more than US$800 billion.

This is a six-fold increase on 2023, prompting questions around sustainability.

The concern has been that this represents a significant overbuild and an unwind could impact the economy and tech valuations.

A decline in free cash flow among hyperscalers – massive cloud service providers such as AWS, Microsoft Azure and Google Cloud – reinforces this concern.

However there is an argument that the spend is sustainable – that this is replacement spend, not incremental, and is driving productivity growth.

This is reinforced by strong gains in revenue per employee at Microsoft, Amazon, Alphabet and Meta.

There is also a case that the model for technology use is changing, which alters the growth rate for the sector:

• The old constraint was humans using a PC and a smartphone for human-to-human or human-to computer interactions, which had finite demand for computing power
• The introduction of AI agents interacting with each other drives a step-change in demand for computing power which drives quicker growth, as seen in the surge of demand for AI tokens (the unit of data that AI models use to process information) in recent months.

Under this scenario the investment spend is justified, which gives confidence to the sustainability of Nvidia growth and its valuation.

Private credit concerns

This is the third big issue for markets, emphasised by two developments last week:

1. A renewed focus on the issue of “double pledging” of collateral in asset-backed loans following the collapse of a small UK mortgage lender MFS. This affected US investment bank Jeffries, knocking its stock down 9%.
2. Ex-Goldman Sachs CEO Lloyd Blankfein warned of the risks of taking private credit products to retail investors in a Wall Street Journal article. Losses in the sector would put it in the cross-hairs of government and regulators, he said. This highlights the issue we discussed in last week’s note, with the use of listed Business Development Companies (BDCs), several of which have performed poorly.

These concerns affected both the broader bank sector – on concerns of their funding exposure to these vehicles – and the alternate asset managers, which have fallen sharply.

Other key data points

The January US producer price index (PPI) came in higher than expected, reinforcing concerns at the margin that progress on inflation has stalled.

Headline monthly PPI was +0.5% (versus +0.3% expected) and +2.9% yearly (versus about 2.6% expected). Core monthly PPI was +0.8% (versus +0.3% expected) and 3% yearly.

The upside surprise was driven by services, rising about 0.8% for the month due to transportation costs, financial services and labour-intensive components. Goods prices fell modestly.

The impact from commodity prices is something to watch as we saw in 2022. Should events in the Middle East impact energy prices it would be reflected here.

The bond market didn’t really react to the data, with the focus on structural issues around AI on the labour market seeming to suppress bond yields.

Australian inflation

January’s monthly consumer price index (CPI) was marginally higher than expected at 3.84% yearly (0.1% above forecasts). Trimmed mean was 3.36% (versus 3.3% expected). The three-month annualised figure was 3.36%, which is not slowing.

Other underlying measures, stripping out more volatile components, are running in the 3.3% to 3.5% range.

This reinforces inflation concerns, though the market did not see it as enough to drive the RBA to raise in March.

Instead, consensus is they will wait for the more detailed quarterly data, with a May hike now at 70% probability.

The market has raised the likelihood of a third hike this year from 40% to 60%.

Markets

One of the US market’s key features is the high level of stock volatility relative to index volatility. This has reached levels last seen in the GFC.

This stock dispersion reflects the high level of uncertainty in the market, which is tied to significant structural and geopolitical issues we’ve been discussing.

The near-term outlook for equity markets overall is likely to be shaped by events in the Middle East.

The underlying US economy is in good shape and the Fed has scope to cut rates, which should mitigate against any over-reaction.

Australia

February proved to be a strong month with the market +3.9%, taking calendar YTD returns to 5.7%, well above the -0.8% and +0.7% respectively in the US.

This reflects the structure of the market, with the US skewed to tech. US banks have also materially underperformed ours.

February’s gains were led by:

• Banks (+13%) with the Big 4 seeing earnings upgrades driven by margins and markets income.
• Miners (+9%) helped by a rotation to hard assets on geopolitical fears, disruption in lithium, and a well-received update from BHP.
• Consumer staples (+5%) driven by a good result from Woolworths.

The laggards were:

• Healthcare (-13%) on earnings and de-rates at Cochlear, CSL and Pro Medicus.
• Technology (-8%) on fears AI will kill SAAS business models.
• Consumer discretionary (-6%) on concerns over domestic rates following the inflation data and more patchy sales signals.

The other feature of the market was a large divergence between mega cap and small cap with the ASX20 +7.9% and the ASX Small Ordinaries -2.6%.

This reverses the outperformance of smalls since the last reporting season (although adjusting for the small cap gold exposure the top 20 has materially outperformed).

It is worth noting Commonwealth Bank rose 17% and BHP 15.5% for the month, which suggests returns were impacted by transition flows as more money went into index-trackers.

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