We are at an interesting point in the markets and in the global economies. I guess it is relatively clear that oil is still “King Oil.” Even though we are doing all that we all can to try and decrease the reliance on carbon fuels, the fact remains that it is still used in manufacturing of almost everything and therefore continues to a linchpin to the functions of many economies. What we are also noticing is that the war in Iran and the immediate area is taking the spotlight off of the + or – of AI and its ultimate benefits or detriments.
In today’s note, I want to give a bit more color to the war effort and what effect it seems to be having and then go into more detail on AI. At the end I will finish with some final thoughts as they pertain to what we are experiencing and what could be expected moving forward.
Oil has just started to do what oil loves to do in a real crisis: it does a moonshot to the upside then it tends to fake everyone out with a whiplash pullback. We're talking WTI (West Texas Intermediate) ripping 60%+ in 30 days, with a 50% explosion in the last week alone, gas jumping 14% in seven days to $3.40+ nationally. But should this oil shock actually create destructive, runaway inflation in the U.S. economy? Unlikely.
First, the World Bank laid it out cold two years ago: Over the last five decades, oil price shocks drove over 38% of global inflation variation, way ahead of demand shocks (28%) or anything else. A 10% oil spike historically adds ~0.35% to global inflation in a year, 0.55% over three. We've seen way more than 10% recently, so on paper that screams higher inflation ahead. But zoom in on the U.S. and the picture changes fast. Why the disconnect? Oil matters a ton as an input for making stuff, but U.S. consumers spend way more on services (which barely touch oil) than goods. Energy is only 4–5% of the CPI basket. Housing? Up to 35%. And Truflation data already shows U.S. housing in outright deflation (~1.5% down over the last 12 months). That's a massive anchor pulling the other way.
Then there's the bigger structural shift the doomers keep ignoring: Higher oil is like a tax on households, but that tax has shrunk dramatically. U.S. gasoline consumption fell 4% from 2007 to 2025 while real GDP grew 42%. Energy's share of household spending dropped from 5.7% to 3.7%. Shale turned us into a net petroleum exporter and a big natural gas seller, meaning higher prices hurt consumers but boost producers, jobs, tax revenue, and the trade balance. It's not the 1970s anymore. No 1970s-style melt-up unless this drags into a true multi-year mess, which incentives say it won't.
Indeed, every player in this Iran mess has skin in the game to end it fast. Trump wants a quick "victory" photo op. Iran wants the bombs to stop. China needs steady oil imports for its factories. Europe just wants the nightmare to end so stability returns. Short war = short oil spike. Short spike = no persistent inflation tail. No persistent inflation = the Fed stays boxed in by deflationary forces and eventually has to cut rates and print to keep the show going. Bottom line: the 1970s were a perfect storm of dependence, inefficiency, and policy blunders. Today's buffers, diversification, and quick-resolution pressures make a crippling repeat unlikely. The U.S. economy is far more resilient than the perma-bears screaming "stagflation apocalypse" want to admit.
Taking this into account, I want to reflect on the underbelly or strength of the global economies. The global economy clocked in another month of strong growth in February, according to the latest global PMIs. The global composite (services and manufacturing) PMI climbed 0.8 points to 53.3, the highest level since May 2024. This puts the composite significantly above its recessionary threshold of 47.8, a situation that has typically been associated with the worst cyclical bear markets in equities. Moreover, the recent increase in PMI momentum over the past couple of months has triggered a bullish signal for global equities. Leading indicators within the report, including new orders, backlogs, and future output, suggest faster momentum in the months ahead.
This latest data precedes the start of the war in the Middle East. Indeed, both the services and manufacturing sectors showed strong aggregate growth in February, a situation we haven’t seen in many years, as manufacturing has struggled to recover. Given the much stronger growth outside of the U.S., the spread between the U.S. composite PMI and the global composite continued to narrow (a trend we’ve been observing since last summer), which has historically been associated with downside risk to U.S. equity relative strength. Don’t take this to mean economic decline here in the US and therefore equity market decline. Instead, what we are seeing in expansion abroad. The closure of the Strait of Hormuz should disproportionately have a more adverse impact on Asia and then Europe. And, a rising index has tended to put upward pressure on global inflation. But compared to the last energy/war shock in 2022, supply chains are much more balanced now, indicating a more favorable starting point.
Here is a picture of the Manufacturing index or ISM here in the US:
What is important here is the action of the equity markets following periods of expansion. And specifically, since it has really been so long since manufacturing expansion, the positive effect on US markets that could be experienced.
What’s really going on in the AI rush
Last year many folks predicted the demise of the Magnificent 7’s dominance, and it didn’t happen. What’s different now is that artificial intelligence has thickened the pot. For starters, many of the largest Software companies are spending jaw-dropping money on data centers and chips. This, I feel, is the most important point that I have really been scratching my head about. Peter Berezin, chief global strategist at BCA Research, notes that the “hyperscalers are set to spend $670 Billion on capex (capital expenditure) in 2026. This is up from $410 Billion in 2025 and $240 Billion in 2024.
As a result, free cash flow at these software behemoths is plummeting and has already turned negative at Oracle. This is because this massive spending spree lowers the heretofore bountiful margins of these giants and makes their financials more opaque as they tap Wall Street for complex loan and funding strategies. Berezin went on to say that technology companies have historically generated profits from three sources,: economies of scale, network effects, and proprietary technologies. A lot of this could now be threatened by AI. But my ultimate question is, “At what point is it that companies are spending so much on AI infrastructure (Capex as it is known) for the sole purpose of staying competitive? Is it that they are truly scared that AI’s open-source format is growing so fast that if they don’t spend these disgusting large Billions of dollars that they will be left in the dust and become a dinosaur virtually overnight?” Think about it, management teams sitting around saying, “Hey, if we don’t spend on the infrastructure, then we aren’t competitive and we will lose our precious relationships. Who cares if we are making money right now (free cash flow), we need to protect our relevance and our client demand fulfillment.”
This last point is a question that will only become clear in the future. There will be winners and there are sure to be losers, but in the end it is still undeniably clear that AI IS THE FUTURE and remaining relevant is paramount.
The last point I want to bring up is the current market environment. This is super important as there are changes afoot that need to be respected. First of all even after a terrific year once again for the S&P 500 last year- up over 16%, the international markets, predominately the emerging markets, beat the US- up 32%! This is the first time in 16 years. And, as of last Friday, the movement in the price of Gold, Oil, and leading agricultural commodities have put the broad commodity sector in front of US Equities as well. See Dorsey Wright’s DALI report below for Monday, March 9, 2026:
Again, this doesn’t mean that the US markets are dead, particularly when taking into account the shear size of the US equity market relative to the International Markets and Commodities. What this tells us is that growth, as I explained above with global PMI’s and domestic ISM growth are giving other asset classes their day in the sun. How long will this last? Until it ends. Hence the beauty of following Dorsey Wright’s incredibly valuable information.
Here are the two graphics that I came in to work to see at 5:30 AM Monday morning:
Take a moment to refer to the larger DALI graphic above and notice the small arrows next to Commodities and Domestic Equities. I bring this to your attention in the weekly commentary as this very seldom happens. These changes are really quite important and should be respected.
This brings me to my final point, what does this say about how money should be deployed and invested and should the conflict going on in the Middle East dictate how an investor should take action? For every person this is different, but all the same, this year tends to be a bit of a tough year for a number of reasons. Opportunities will of course present themselves, but more caution than we have needed to apply over the last number of years may be warranted.
- Ken South, Tower 68 Financial Advisors, Newport Beach
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