Market Is Rushing To Price In Worst-Case Scenarios

The market is constantly changing. Correlations shift, new products come online, narratives change, and so on. While the market tries to quickly get prices right as information comes, there’s been an increasing tendency to overreact to news, then pull that back.

For instance, when the Strait of Hormuz was considered effectively shut in early April, oil (see below) swiftly rose, hitting highs not seen since. The market priced in a very bad case that subsequent strikes, blockades, and so on wasn’t able to exceed. The rush to get out tends to exceed the severity of the problem.

Similarly, today many AI stocks are getting hit fairly hard. The reason broadly cited has been a story that OpenAI is pausing training, evaluation, and tool-use of the best models as they slipped containment. The fear is that this will slow spending on AI models, hitting the stocks involved.

Realistically, we’ve already played this game earlier this month with all the “pace the frontier” talk. I even wrote about it two weeks ago, Freakout. My conclusion then, which still seems true, is that all this is a political power play designed to benefit OpenAI and hurt competitors.

Selling AI stocks on a story that got little attention seems silly, but it’s still happening. Why did this news suddenly have such an effect? I think that gets us back to the eternal story, rates hitting new records every day. That has an effect, and eventually AI stocks look to expensive versus the rest of the market to not be sold. The story over the weekend just provided a convenient excuse as to where to put the selling pressure from high rates. Once again, rates are the story.

Fortunately, eventually rates start to hit a short-term limits on how far they’re likely to go. We’re already pricing in a 60% chance of two rate hikes this year, and we’re 30 days from the next meeting. With so much time until the next meeting, how much more certainty can the market have on rates?

The market attempted to rapidly price in a recycled story into AI stocks. The original story had no lasting effect and I don’t see why this time would be any different. In this case, I think it’s more about providing a convenient release valve to rate stress. A lot of problems can be solved if rates relax and we’ve already priced in quite a bit in a short period. Perhaps we’re poking around peak rate pain, at least for a time?

Dallas Fed Manufacturing was 9.8 vs. prev. 11.6, with production holding up but future expectations slowing.

Iran says they expect a response today on their proposal to open the Strait of Hormuz.

Jefferies (JEF) economist David Zervos was named by Treasury Secretary Bessent as an adviser through April. Zervos has been a fan of rate cuts for a while, so this looks dovish.

New highs vs. new lows in the NYSE is the worst since 2023, a sign not many stocks are participating in this upside.

JOLTS (job openings) today, along with lots of Fed speakers.

Bottom line: Markets are watching for rate and oil relief

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