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 maritime navigation 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-shoring? These questions may only become clearer around April. Faced with great uncertainty, the market has seen some short-term profit-taking, with previously strong-performing assets experiencing recent declines. Overall, most of the performance and narrative-driven market signals since the beginning of the year have returned to the same starting line; the first three months can be viewed as a market rotation driven by expectations and narrative battles during spring turbulence and cooling, not the definitive trend 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 key decisions will depend on April.

Divergence in Market Expectations Regarding the Iran Conflict’s Trajectory and Impact

1. “Decreased conflict intensity, timely TACO” vs. “Maritime navigation not yet restored, chemical supply chains not truly reflecting supply disruptions.” The first view: Since the outbreak on February 28, 2026, the US and Israel have carried out targeted high-level eliminations of key military and political figures in Iran, confirming or highly likely killing at least 22 core figures 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 view: Iran conflict remains highly unpredictable; unless maritime traffic normalizes, marginal trading changes could be disrupted by new shocks at any time. Currently, maritime traffic has not recovered; as of March 19, 2026, the number of oil tankers passing through the Strait of Hormuz remains in the low single digits per day. Additionally, the current spread between Brent crude and Dubai/Oman spot prices is very 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 levels.

2. “Clear risk of stagflation and tightening liquidity” vs. “Employment prospects more affected by AI, making tightening difficult.” The first: 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, posing a significant liquidity challenge. After the March 18 Fed meeting, implied rate cuts in the CME FedWatch tool remain at 0-1 times this year. The second: AI infrastructure investments will continue; 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, and the employment impact is not yet fully visible, though layoffs at major firms are increasing. In an environment of strong industrial demand and weak consumption (similar to China 2021–2023), the Fed is unlikely to tighten solely due to energy cost shocks.

3. “Prolonged conflict would significantly impact China” vs. “China’s supply chain resilience is strong, and oil dependency has notably decreased.” The first: China’s high reliance on oil imports, especially from the Middle East, means about 36% of total oil imports in 2025 pass through the Strait of Hormuz. Many Asia-Pacific countries face similar issues; thus, ongoing conflict would greatly increase China’s energy costs, while the US is largely self-sufficient in oil and resources. The second: Looking at the ratio of oil imports to GDP, China’s share has decreased from 2.2% fifteen years ago to 1.7% (around $80 Brent) in 2024. Current domestic inventories, including strategic reserves, can cover over 90 days of consumption. Additionally, China’s capacity for energy substitution via coal chemical and green alcohol routes remains ample, with room for wind and solar integration, potentially replacing some oil demand. More importantly, China has long-term energy diversification strategies; according to the “2025 Domestic and International Oil & Gas Industry Development Report,” Russia, the Americas, Africa, Central Asia, and surrounding regions could supply an additional 130 million tons annually, combined with domestic production potential of 20 million tons and strategic reserves, totaling about 180 million tons—covering the Strait of Hormuz risk exposure of 185 million tons. A more likely scenario: disruptions in European, Japanese, and Indian supply chains could shift demand toward China, accelerating the alleviation of China’s own energy overcapacity issues, similar to post-pandemic supply chain reallocation.

Three Core Unverifiable Questions for the Market

1. After conflict intensity decreases, to what extent can maritime navigation recover? As of March 19, only five ships (four small bulk carriers and one refined oil tanker) are passing through the Strait of Hormuz, 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. Navigation now shows significant “camping” features, with only certain ship registries permitted through 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 List reports Iran has established “safe corridors” within its territorial waters, implementing conditional paid passage mechanisms—compliant ships must pre-report owner info, cargo destination, etc., and undergo Iranian verification. Some oil carriers have paid $2 million for passage rights. Currently, 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 passing.

2. Does the Fed prioritize inflation indicators or focus more on employment? The Fed’s March 2026 meeting kept rates steady at 3.50–3.75%, maintaining a hawkish stance as expected. Regarding Middle East tensions, Powell reiterated “wait and see,” noting uncertainty about the scale and duration of shocks, and that traditional views tend to “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 remain nearly unchanged. The labor market is also softening: February non-farm payrolls showed negative growth; December and January data were significantly revised downward. The Fed’s latest SEP removed the phrase “unemployment rate has shown signs of stabilization,” reflecting concerns about ongoing employment weakness. As exemplified by the capabilities of coding agents like Opus 4.6 and GPT 5.3 Codex launched in early February, the impact on employment remains uncertain, though layoffs at major firms are increasing. These factors make Fed policy balancing more difficult; as a data-driven institution, the Fed is likely to remain cautious and avoid clear guidance.

3. Is China facing cost shocks or opportunities from supply chain re-shoring? High-frequency data show initial transmission of spot and futures prices. Logically, supply shocks ultimately boost profit margins in key segments of the supply chain—China’s supply chain remains resilient. However, the core issue in markets is “priced but not traded,” meaning it’s not yet the right time for contrarian positioning. Downstream manufacturers, before volatility in crude oil and commodities subsides, tend to hold back inventory purchases, fearing “buying at high prices.” As long as inventories are not exhausted, they are likely waiting for the conflict to stabilize and for commodity volatility to decline. Therefore, the industry’s profitable margins are expected to reflect spot prices after stability returns. This explains the divergence between stock and futures/spot trends. Until commodity volatility decreases, the market is mainly influenced by narratives and liquidity shocks, not frequent price signals, and long-term narrative battles dominate.

Short-term Market Adjustments and Recent Declines in Previously Strong Assets

Since March, the structure of declines and relative performance of institutional holdings do not align. The top four sectors heavily held by institutions have fallen an average of 5.6% since March; notably, the electric power and communication sectors have gained. Conversely, the four sectors with the lowest institutional allocation have fallen an average of 8.9%. This suggests that the main driver of volatility is not institutional rebalancing but rather the reduction of absolute return funds. In terms of style, low-valuation stocks are safer, while high-valuation stocks have fallen more sharply; stocks with higher recent gains have experienced larger declines, consistent with absolute return fund de-risking. In a phase where valuation levels are high, profit margins are yet to be realized, and macro uncertainties increase, de-risking by absolute return funds is rational. At this stage, fundamentals give way to liquidity and narratives; stocks that surged on narratives in January–February have seen more intense corrections in March. This is normal, and there’s no need to over-interpret price movements.

Returning to the Starting Line—Decisions Will Be Made in April

1. Core uncertainties about the Middle East conflict will gradually be clarified after April. The key market questions will be answered in the coming weeks, but until then, the market remains in a narrative battle, reflecting liquidity withdrawal. US Treasury yields are rising rapidly, 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 is just beginning to shift toward pricing power and profit margins. From a trading perspective, rising prices and PPI rebound are ongoing signals; the main concern is upstream prices’ difficulty in passing through 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, and whether firms can maintain profit margins and gain pricing power remains to be seen. Investors should remain patient and calm through price fluctuations. April and May are critical decision months. Even if early-year sector rotations driven by narratives do not yield immediate gains, it’s not a problem—active equity funds’ median return for the year has already returned to 0.7%.

2. Maintain a strategic focus on China’s manufacturing and pricing power. The current core holdings should emphasize industries with a competitive advantage in China, high overseas re-shoring costs, 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, with significant expectations gaps and undervaluation. Building on these core holdings, increase exposure to low-valuation factors, focusing on insurance, securities firms, and power. Short-term signals suggest that price increases remain the “sharpest sword,” and PPI trading is increasingly likely to be the main theme for the year, with April–May as a decisive period. Prioritized opportunities include: 1) chemical products with alternative raw materials/process routes benefiting from oil price shocks (China’s “coal content” in these products is often higher than overseas competitors); 2) supply disruptions in products previously reliant on Middle Eastern/Western European capacity, potentially creating supply-demand gaps and price increases; 3) demand-driven price hikes in substitutes affected by costs; 4) products already in an upward price channel, where rising costs create favorable pricing windows 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
• Excessive tightening of macro liquidity domestically and internationally
• 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)