Author: Damir Tokic , Professor of Finance, Analyst at Seeking Alpha
Led by tech stocks, the S&P 500 is approaching its all-time high valuation, suggesting a massive bubble has formed. Meanwhile, the potential for an Iranian war to trigger an inflationary shock, leading to soaring oil prices and higher US Treasury yields, and the escalating situation significantly increases the likelihood of this pessimistic prediction becoming a reality. Although the Federal Reserve is currently maintaining an accommodative stance, the market has already begun pricing in interest rate hikes. Therefore, a hawkish shift by the Fed in June could very well be the trigger that bursts this bubble.
President Trump attends the swearing-in ceremony for the new Federal Reserve Chairman
Does a ceasefire agreement only benefit tech stocks?
The following is the performance of the S&P 500 (SPY) over the past three months since the start of the Iran-Iraq War:
Since February 27, the S&P 500 has risen by 10%.
The technology sector (XLK) saw gains exceeding 37%.
The second-best performing sector was the consumer discretionary sector (XLY), which rose by only 3%. It's worth noting that Amazon (AMZN), which accounts for 27% of the XLY weighting, saw its stock price rise by 28%; Tesla (TSLA), which accounts for 20% of the XLY weighting, saw its stock price rise by 8%. Both companies are essentially technology companies and members of the "Mag 7" tech giants.
So, what is the core question now? Does the ceasefire in the Iranian war only bring absolute benefits to the technology sector, especially the semiconductor field (SMH)?
From my perspective, the answer is no. The market previously blindly believed the war was over, and more importantly, it thought we could escape the inflationary shock and the ensuing demand-destroying recession. This, in turn, became a green light for speculators to ramp up their activities and re-inflate the bubble.
However, it must be pointed out that the current bubble is different from the dot-com bubble of 2000. The 2000 bubble was entirely driven by the disorderly expansion of expectations and price-to-earnings (P/E) ratios. The bubble of 2026 is far worse! It is built on "backward" vested profits and the naive expectation that these profits will continue indefinitely. Specifically, major mega-corporations have poured $770 billion into AI capital expenditures, and clearly, these profits are concentrated in the core beneficiaries of this capital expenditure, primarily semiconductor companies like Micron Technology (MU).
However, the cyclically adjusted price-to-earnings ratios (Shiller P/E) in 2000 and 2026 are almost identical, both remaining above 40. In other words, the severity of the bubble in 2026 is comparable to that in 2000.
However, tech giants cannot continuously cash out their profits. The growth of AI capital expenditures is likely to slow and eventually decline. When will this happen?
In my view, this $770 billion AI capital expenditure can be traced back to a meeting Trump had with tech executives early in his second term. At that time, President Trump sat next to Zuckerberg and asked him how much Meta planned to spend on AI capital expenditure. Zuckerberg replied, “Sorry, I’m not ready yet… I’m not sure what number you want.”
Therefore, I believe that this $770 billion AI capital expenditure is essentially a "Trump stimulus plan" imposed on private companies by Trump, and it is unsustainable. This trend is likely to reverse if the Democrats win the upcoming midterm elections.
Therefore, the market's frenzied reaction after the ceasefire in the Iran-Iraq War was merely part of Trump's stimulus plan, and likely a final, frenzied rally. The question now is, where will this surge peak? And what will trigger this crash?
SPY sector performance (Data source: SSGA.COM)
Iran war escalation and inflation shock
Now let's turn our attention back to the Iran war. This is a crucial variable because it has the potential to trigger a classic systemic shock, thus completely bursting the bubble.
A classic bubble burst typically follows this trajectory: 1) inflation intensifies, 2) the Federal Reserve raises interest rates, and 3) an economic recession triggers a bear market.
Let's first examine inflation. Inflation can be driven by demand or supply.
Demand-driven inflation is initially beneficial to the market because businesses have pricing power. This is often accompanied by an "overheated" economy, allowing businesses to achieve revenue and profit growth in the early stages. The Federal Reserve will then suppress demand by raising interest rates, but this will ultimately lead to higher unemployment and a recession.
In contrast, supply-driven inflation is a major negative for the market from the outset because businesses lose pricing power—this typically occurs in weak or stagflationary environments. The Federal Reserve is forced to raise interest rates in an already weak economy, which inevitably leads to a deeper recession.
The war in Iran is triggering a devastating supply-side inflation because it has created a global energy shortage, as well as a food shortage due to fertilizer shortages and many other derivatives and chemicals.
Essentially, Iran has closed the Strait of Hormuz, and this closure has lasted for three months. During these three months, the global economy has been drawing on strategic petroleum reserves to fill the oil gap, and these reserves are expected to reach critical operational levels in June.
If Iran does not immediately reopen the Strait of Hormuz, the global economy will face the most severe energy shock in history. Due to a real physical shortage, crude oil prices could surge to over $200 per barrel until demand is completely destroyed, causing prices to fall. This destruction of demand directly corresponds to an economic recession.
That's why Trump is acutely aware of the gravity of the situation. For the past two months, he has been trying to negotiate with Iran to reopen the Strait of Hormuz, but all efforts have been unsuccessful.
At present, reaching an agreement with Iran is almost impossible for three reasons:
First, Iran wants to maintain control of the Strait of Hormuz even after it reopens, which crosses a red line for the United States.
Second, Iran's refusal to negotiate on the nuclear issue, and its high probability of not wanting to reach any nuclear agreement, is another red line for the United States.
Third, even if Trump compromises with Iran's conditions and reaches some kind of agreement to reopen the Strait, Israel will intervene to stop it, because Israel sees a nuclear-armed Iran as a life-or-death threat.
So, what is the actual situation now?
My view is that the likelihood of Trump reaching a last-minute agreement with Iran to stem the inflationary shock is increasing.
However, Israel absolutely does not agree to this agreement. Part of the Iran nuclear deal requires a ceasefire on all fronts, including Lebanon. Israel could easily veto the agreement by directly attacking Lebanon. For Israel, this is a matter of life and death, given that Hezbollah, its "neighbor," is a real threat.
We are currently facing a potential major upgrade.
Reports indicate that Iran has cancelled all contact with the United States, meaning all negotiations have stalled. Furthermore, Iran has completely blocked the Strait of Hormuz and threatened to further close the Bab el-Mandeb Strait. If this were to happen, over 30% of the world's energy supply would evaporate —a true catastrophe.
Despite Trump's claims that he has spoken with Israel and Hezbollah, and even that negotiations with Iran are ongoing—statements that alone were enough to propel the tech sector to record highs—no official confirmation has been received to date.
June crash
Therefore, the probability of a collapse in June is becoming increasingly high. Global oil inventories will reach a critical level in June, and once they fall below that line, crude oil (CL1:COM) prices will surge due to a genuine supply shortage, at which point it will be difficult to maintain oil prices based solely on rhetoric.
As a result, bond yields will soar as inflation expectations rise and fiscal concerns drive up real interest rates . Furthermore, when inflation surges, verbal intervention to deter a sell-off in the bond market will become ineffective.
Most importantly, the Federal Reserve must respond at the June FOMC meeting. This could very well be the final trigger to burst the bubble. Specifically, the Fed's current quarterly summary of economic projections (SEP) continues to signal that the next move will be an interest rate cut, maintaining an accommodative policy stance.
However, the federal funds futures market has already priced in the tightening bias, and the market currently predicts a greater than 50% probability of a rate hike before December 2026, and even the possibility of two rate hikes.
The Federal Reserve will then have to conform to market expectations and officially shift to a hawkish stance at its June meeting. This alone could cause the bubble to burst instantly. Even if the Fed insists on maintaining a dovish bias, the complete loss of market credibility would likely cause a surge in the 10-year Treasury yield, triggering an even larger systemic shock.
Investment Insights
The S&P 500's cyclically adjusted price-to-earnings ratio is currently approaching a new historical high, well above 40, forming a massive bubble. The inflationary shock triggered by the Iran war could burst it at any time, and the Federal Reserve's hawkish shift in its official stance in June could be the fatal bullet. Investors should prepare for a significant pullback, potentially as severe as the bear markets of 2000 and 2008. Remember, bubbles always burst.
