Markets are hitting record highs, and investors are more bullish about US stocks two months into the Iran war than they were when it started. UBS thinks reality is taking the slow route in.
UBS chief economist Paul Donovan put a name on the moment: the Wile E Coyote effect. In the old Roadrunner cartoons, Wile E Coyote sprints off a cliff, hangs in mid-air for a second, then drops once he looks down.
Donovan thinks developed economies like the US and UK are doing the mid-air sprint right now. "This cannot carry on forever, but economic gravity has yet to exert itself," he wrote in a recent note to clients.
The cliff in this case is high oil prices feeding into broader inflation, plus the slow drag of the Middle East conflict on global trade.
Consumer spending has been the surprise of the last two months. Even with consumer confidence hitting record lows, Bank of America has reported that total spending is still rising.
The catch is who's doing the spending. The strong numbers are concentrated at the top of the income ladder, while lower-income households are pulling back.
That's the K-shaped economy in action - one slice of consumers driving the data and the other slice falling behind. It's the kind of mix that looks fine in a top-line spending report and a lot less fine when you split it apart.
By the numbers: Higher-income households are responsible for the lion's share of recent spending growth, while gas prices alone have eaten into lower-income budgets first.
Stocks tell the same story in a different way. Equities have hit record highs during the war, even as analysts have been warning about an oil shock and possible disruptions through the Strait of Hormuz, the choke point that handles a big share of global oil shipments.
Piper Sandler's chief market technician Craig Johnson is still bullish on US stocks long term, but he says the surface is hiding the setup. He described the current market as one where investors are trying to outrun a bear they can't see clearly.
That bear, in his framing, is the economic damage from the conflict if the war drags on or knocks out more oil supply. "People are overlooking these higher oil prices because they don't know how to trade a geopolitical conflict," Johnson said.
AAII data backs up the disconnect, showing investor sentiment is now more bullish than when the fighting started.
For investors, the case to watch is simple. Either the war ends quickly, oil prices ease, and the cliff turns out to be a slope, or the gravity Donovan keeps pointing at finally shows up in the data and forces a reset across stocks, bonds, and consumer spending.
Right now, the market is betting on option one.
