Strait Talk

On the One Hand

Soundbite: The heaviest crude oil shorts in memory set up a violent price reversal sparked by the attack on Iran. Iran’s response can span from full compliance (completely abandoning their nuclear ambitions) to outright defiance (attacking U.S. bases and putting mines in the Strait of Hormuz). Markets are opening with rumors of the Iranian government ready to abandon enrichment, but for now, that is mere hope. If Iran chooses to ramp up their aggression, oil analysts cannot rule out a move as high as $130, which would almost guarantee a recession. In June 2008, February 2000, and September 1990, crude oil doubled over the year, and it is no coincidence that a recession ensued each time. That is why Iran’s actions matter.

Concerns about oversupply and weak demand pushed WTI crude futures to a $55 low in Q2, a 20% drop from year-end levels that completely reversed last week. Although Iranian oil output accounts for less than 2% of global production, historically, oil prices are sensitive to even small changes in supply expectations.

If the rumors are true and Iran does dismantle their nuclear capabilities, that, of course, is extremely bullish. However, if Iran reverses course and announces it will sink any ship moving through the two-mile wide shipping lanes of the Strait of Hormuz, maritime insurance companies will pull coverage. Given that a fifth of global oil production passes through those lanes, JP Morgan estimates that a supply embargo has the potential to drive crude prices to $130. Their base case is that oil trades in the $60 range next year, and assumes diplomacy prevails.

The fact that the Iranian government is markedly weakened increases the chances of a closure of the Strait, but bulls are betting this morning that the regime’s exposed weakness raises the probability for successful mediation.

Even in the worst-case scenario, the ability of OPEC to increase production and the U.S. to release a portion of its Strategic Petroleum Reserve serve as partial safety valves. The consumer burden of higher gas prices, which could also lead to higher inflationary expectations, makes a diplomatic solution essential. The alternative is very problematic.

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Immigration and Payrolls: Uncomfortable Bedfellows

Soundbite: Nonfarm payroll growth has slowed to a 1.1% annual rate, less than half the labor growth from two years ago, and a level that has been associated with recessions in the past. Unfortunately, immigration policy is expected to further drop this rate by almost an additional full percentage point this year. Nearly flat annual labor growth occurred in December 1990, May 2001, and April 2008, periods that were extremely negative risk return equity environments. The immigration slowdown weighs heavily on potential growth prospects for the U.S. economy. Unless supportive tax and deregulation policies produce an immediate growth response, the immigration protests will move from the streets to risk markets.

The consensus expectation is for immigration flows to create a contraction in the labor force of 2 million this year. Morgan Stanley forecasts that the contraction, combined with deportations, will push labor force growth down to around 0.25% by year-end. The unemployment rate will begin to rise above 4.2% if payrolls drop below 70,000; the combined effect of the expected contraction in the labor supply plus the difficulty of finding qualified workers could yield depressed payrolls that drop below that critical threshold.

Although payrolls and the unemployment rate are coincident indicators, this year-over-year total employment growth number becomes a critical datapoint for us. Initial claims and continuing claims have more leading tendencies, and those two data series are rising, but have yet to trigger investor concern. We expect negative unemployment headlines as the year progresses, which will weigh on equity market investor confidence.

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Sunnyside Up

Soundbite: U.S. Exceptionalism is not dead. We will continue to enjoy a technological edge and the productivity advances that come with it. However, high valuations are an overhang as the theme is fully priced in. Latin America is exceptionally cheap with ILF, the Latin American ETF, carrying a price-to-earnings ratio less than half that of the S&P 500. The region could be on the cusp of a wholesale political move to the center-right, and their transition to free market economies may represent a way to play America’s resurgence and a move to a multipolar regional world order. In addition to having a low valuation, their currencies are depressed, and if Argentina is a leading indicator, its neighbors should outperform any U.S. rally. This could make U.S. investors the beneficiaries across three dimensions of profitability.

Rob Citron of Discovery Capital Management mentioned his expectation for a strong economic turnaround in the U.S. by the 3rd or 4th quarter of this year. However, he is not looking to load up on U.S. equities, preferring South American markets. We can see a dramatic change in the continent's political and economic profile with four major elections within a single year. Starting with the Chilean general elections on November 16, 2025, Peru’s national election is scheduled for April, Colombia's in May, and Brazil is in October 2026.

On a relative basis, each of the four countries’ stock indices have not broken out against the S&P 500. Argentina may be a leading indicator; the MSCI All Argentina equity index doubled the S&P 500’s gain since 2023. Argentina started to break out in January 2023, before the far-right outsider Javier Milei won in November of that year. As the new Argentinean president, he cut 20% of all government jobs and reduced the size of the tax authority—both of which sound familiar for Americans. Washington must take note that Milei followed through with a third important promise, that of cutting federal debt dramatically.

Assuming a contained Middle East conflict, the consumer and investor confidence swing seen in Argentina could easily be the blueprint for these four countries. Europe and China have seen strong capital inflows at the expense of the U.S. since the beginning of the year based on their fiscal expansion versus fiscal contraction in the U.S. We are on the lookout for signs that this capital outflow will direct itself to the South as investors anticipate change.

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What to Look for This Week

(All times D.S.T.)

1. Aside from the main event Wednesday, June 18 at 2:00 p.m. the FOMC rate decision and more importantly their quarterly Summary of Economic Projections: Tuesday June 17 at 10:00 a.m. the National Association of Homebuilders Housing Market Index for June. The index is near multi-year lows, so we are eager to see the data. Homebuilder stocks have underperformed for the last three quarters.

2. Wednesday, June 18 at 8:30 a.m. U.S. Building permits for May. The series has been holding at 5-year lows, similar to the NAHD data above. New privately owned residential construction permits are our favorite housing indicator.

3. Wednesday, June 18 at 8:30 a.m. Initial Claims for the second week of July are released. The 4-week moving average (preferred due to noise) is accelerating higher. As long as the latest number does not drop by more than 22,000, the moving average will stay at recent highs. Continuing Claims is lagged by one week, so the first week of June will be out simultaneously, after spiking by a large amount at the end of May.

FOMC Voters Speaking: Blackout period in effect and there are no Fed speakers until next week.

A pile-up of Central Bank Meetings: Monday June 16 at 10:30 p.m. the Bank of Japan’s Monetary Policy Statement is released. The Ueda press conference is Tuesday June 17 at 2:30 a.m. Thursday June 19 at 7:00 a.m. the Bank of England’s Monetary Policy Committee will release its interest rate decision and minutes (highly recommended). The Swiss National Bank also meets Thursday and is expected to cut rates.

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