WALL STREET IS DANCING ON A VOLCANO

Wall Street is dancing on a volcano. Welcome back to Wall Street Decoded. Today, we have a special newsletter. The current economic picture is torn between the extreme euphoria of the AI technology boom and the deepest geopolitical fractures in decades. If you just glance at the ticker boards, you will see a brilliant bright spot. However, as someone closely tracking the flow of smart money, Elise's assessment is not entirely positive. We appear to be walking on very thin ice. 1. The Bright Spot The lifeline from the tech big four and the AI wave. The reason the market is still standing firm amidst tense geopolitical contexts is that Wall Street is placing its full faith in the earnings reports of the big tech group. The technology sector's earnings in the first quarter are projected to grow by a staggering 41 percent, the largest increase among all sectors in the S&P 500. The big four group consisting of Alphabet, Microsoft, Amazon, and Meta is shielding the entire market. Notably, capital expenditure, CapEx, on AI by these four tech giants is forecasted to exceed the $500 billion mark by 2026. Thanks to this massive capital injection, the S&P 500 and Nasdaq indices remain continually anchored despite the specter of war. Major technology companies are completely immune to supply chain shocks or the weakening of consumer spending. However, the market is treating AI as an omnipotent shield, and this has led to excessive optimism. 2. The Dark Spot A historic bubble has formed this is when we must look at the risks being ignored by the market. According to an assessment by Crescat Capital, the U.S. stock market is historically overvalued. A red alert sign has appeared. Warren Buffett's favorite indicator, the market capitalization-to-GDP ratio, has just hit a new record of 228 percent, which is a full 59 percent higher than the peak of the 2000 dot-com bubble. The RSI indicator of the S&P 500 bottomed out below 30 in late March, but then snapped back above 70 by mid-April. This is the second-fastest weak-to-strong recovery since 1950. Pairwise correlations among stocks in the S&P 500 are at their lowest level since just prior to the Volmageddon crash in 2018. This indicates extreme complacency. Investors are blindly picking individual stocks and completely ignoring macroeconomic systemic risks. 3. The Stagflation Spiral and the Impotence of Central Banks While the Stock Market Soars The real economy is facing a stagflation shock, high inflation coupled with stagnant growth. In Europe, the European Central Bank, ECB, is facing a headache. Bond yields are rising and loans are becoming increasingly difficult to access, yet inflation is exploding. The April PMI shows that business activity has contracted, with costs increasing at a record pace for 25 years, excluding the pandemic period. Consumer inflation expectations for the next 12 months surge to 4% in March. However, borrowing costs may remain stuck at 2% because the data is too noisy. In the U.S., the Federal Reserve Fed is also in a wait-and-see situation. Core and headline PCE inflation in upcoming data are forecasted to exceed 3%. WTI and Brent oil prices have risen more than 40% compared to before the Iran conflict broke out. Both Powell and potential successor Kevin Warsh are facing an endgame scenario, where the room to cut interest rates is nearly zero due to deeply rooted inflation. 4. The Geopolitical Picture Risks spilling over from Hormuz to Malacca If you think the conflict in the Middle East has already been priced into the market, you are mistaken. The U.S. under the Trump administration is seeking a prolonged blockade against Iran, paralyzing the Strait of Hormuz. Another game-changing event. The United Arab Emirates, UAE, announced it will leave OPEC, dealing a severe blow to the future of the global energy market. Tensions do not stop in the Middle East. The world is turning its concerns toward the Strait of Malacca, the busiest waterway on the planet, where one-fifth of global maritime trade passes through. Look at the numbers. In the first half of 2025, a massive 23. 2 million barrels of oil pass through Malacca daily, surpassing even the 20.9 million barrels of Hormuz, with its narrowest point being only one. Seven miles wide, this is a chokepoint extremely vulnerable to the risk of congestion or conflict. China is falling into the Malacca dilemma, because they crucially depend on this route for oil imports. As the U.S. military announces, it will crack down on the dark fleet transporting Iranian oil through Southeast Asia, the risk of a direct clash between superpowers at this chokepoint is a risk that has not yet been priced into financial markets. Actionable advice from Wall Street amidst this complex macroeconomic environment bearing the hallmarks of the 1970s, defensive strategies are being activated by major institutions. Hedging with precious metals. Gold has edged up to the $4,600 ounce mark. Buying shares of gold and silver mining companies, especially small-cap groups with large-scale exploration projects, is considered the best counter-cyclical shield. Currencies. Macro funds are shorting the USD and going long on the Japanese yen, JPY, based on yield differentials and the Trump administration's directive to weaken the dollar for re-industrialization. Stock market. Do not be complacent. The cost to buy put options to protect portfolios against Fed events is currently very cheap. The implied move of the S&P 500 on Fed meeting days is only 77 basis points. Take advantage of the market's complacency to hedge against downside risks. Dear listeners, Wall Street appears to be dancing on the lid of a volcano. Technology capital flows may continue to anchor the indices for a while longer, but the fractures from stagflation and global maritime choke points will soon demand attention. Protect your portfolio before the real tsunami hits. We must not forget that behind record-breaking highs always lie bottomless abysses. Wishing you clear-headed investing, and see you in the next newsletter.