Markets Hold Steady as War Costs Spread and Tariff Risks Return

Yesterday I wrote about oil rising on Iran tensions while Western equities largely shrugged it off. I noted that the disconnect between energy markets and equity markets couldn't last forever, and that eventually the economic costs of the conflict would start showing up in unexpected places. Today, we're seeing the first clear signs of that spillover. but the market's internal signals are telling a more nuanced story than the headlines suggest.

The S&P 500 edged up 0.11% to 6,583, the Nasdaq gained 0.18%, and the Dow slipped 0.13%. On the surface, that looks like a quiet day. But underneath these flat headline numbers, a more complicated story is playing out. one involving small-cap outperformance, falling bond yields, rising recession fears, and a new tariff threat that landed after the close. Let me walk you through it.

The Real Economy Is Starting to Feel the War

Here's what caught my attention today. Analysts are warning that 1.3 million UK homeowners could see their mortgage payments rise if the Iran conflict drags on, as higher energy prices push up inflation expectations and keep interest rates elevated. In India, beer and bottled water prices are being flagged as potential casualties of surging energy costs. These aren't abstract financial headlines. They're signs that the conflict's economic impact is spreading from oil futures trading desks into everyday consumer prices.

When energy costs start feeding into transport, packaging, and production. and companies begin passing those costs through to consumers. that's a real-world inflation transmission mechanism. When mortgage lenders start issuing warnings, that's a signal that interest rate expectations are shifting. The key question is whether this remains a narrow energy shock or broadens into something stickier.

The UK inflation data this week actually looked manageable, but analysts are warning not to be fooled by the pre-war print. A "brutal" catch-up in prices could be coming as the energy shock works its way through supply chains. I think "brutal" is probably an overstatement, but the direction of travel is clear: inflation risks are tilted to the upside as long as this conflict persists.

The Inflation Picture Gets More Complicated

Speaking of inflation, a global forecasting group now projects U.S. inflation at 4.2% this year. well above the Fed's own estimates. That's a meaningful gap. If they're even close to right, it changes the math on rate cuts significantly.

But here's where it gets interesting. Another analysis today argues that $4 a gallon gas prices won't actually trigger Fed rate hikes. and could even lead to cuts. The logic? Higher energy prices act like a tax on consumers, slowing spending and economic growth. The Fed might look through the energy-driven inflation and focus on the demand destruction instead.

I find this argument compelling but conditional. It only works if the inflation stays concentrated in energy and doesn't spread into wages and core services. That broadening is exactly what we need to watch for. If major retailers start adding fuel surcharges and passing energy costs through to consumers. and if the UK mortgage warnings translate into actual rate moves. the "look through it" thesis falls apart.

Private sector hiring came in at 62,000 for March per ADP, better than expected but still quite soft. That's consistent with an economy that's cooling but not collapsing. And the soft jobs picture connects directly to another headline today: recession odds are climbing on Wall Street as cracks appear beneath the surface. I'd note that recession forecasters have been wrong more often than right over the past few years. but the bond market agrees with the pessimists today (more on that below).

Small Caps Quietly Outperform

One of the more interesting signals today was small-cap strength. The Russell 2000 gained 0.70%. meaningfully outperforming the large-cap indices. The IWM small-cap ETF was up 0.69%, compared to SPY's 0.09% gain.

Why does this matter? Small caps tend to be more domestically focused, so their outperformance could reflect a bet that U.S. domestic demand remains resilient even as global trade faces disruption from both the Iran conflict and tariff uncertainty. It could also signal bargain-hunting after small caps have underperformed in recent weeks. Either way, it complicates the narrative that markets were simply treading water. beneath the surface, there was a quiet rotation toward risk.

Trump's 100% Pharma Tariff Adds Another Layer

As if the inflation picture wasn't complicated enough, Trump unveiled a 100% tariff on drugs to push for pharmaceutical deals. This is the kind of announcement that demands careful parsing. Is it a genuine policy direction, a negotiating tactic to extract concessions from pharma companies, or campaign positioning? Based on the pattern of previous tariff announcements. many of which were walked back or modified before implementation. I'm treating this as a negotiating position until we see actual implementation details.

Notably, the S&P 500 Health Care sector actually gained 0.73% on the day. That might seem contradictory, but the timing matters: the tariff announcement appears to have landed late in the session or after the close, meaning markets hadn't fully priced it in yet. It's also possible that investors are applying a heavy discount to the probability of actual implementation. Either way, healthcare is a sector to watch closely in coming sessions as the market digests the implications. A 100% tariff on pharmaceuticals, if implemented, would fundamentally reshape drug pricing and supply chains.

What This Means for Our Positions

Let's connect today's events to what we actually own.

ConocoPhillips (COP): This is where the Iran conflict is most directly relevant to our portfolio. Our COP position, entered at $131.70, is sitting right in the sweet spot of our thesis: sustained higher oil prices driven by supply uncertainty. The spreading cost-of-war headlines. UK mortgages, Indian consumer goods. actually reinforce the thesis, because they show that higher energy costs are being passed through rather than absorbed, which supports energy company revenues. As long as the Iran situation remains unresolved, the supply risk premium stays elevated, and that's good for COP.

Ethereum (ETH): Our crypto position is essentially flat since entry, with ETH hovering around $2,057 against our entry of $2,056.56. That's a 0.02% gain. about as flat as flat gets. In an environment where risk assets are holding up despite geopolitical headwinds, flat isn't bad. But crypto has been quiet while equities, gold, and oil dominate the narrative. The thesis here was a catch-up rally driven by institutional adoption and risk-on sentiment. With the Russell 2000's quiet outperformance today hinting at some risk appetite beneath the surface, there may be a setup building. but I'd like to see some momentum emerge soon. Our base case target remains around $2,509 within a 3-month timeframe.

The Global Picture: Asia Diverges, Europe Splits, Mexico Surprises

If you've been following this series since our post on divergent markets, you know I've been tracking the split between regions. Today, that pattern continued with some new wrinkles.

Asia was sharply divergent. Shanghai fell 1.02%, Hong Kong dropped 0.70%, Taiwan declined 1.82%, and Australia lost 1.06%. all consistent with the drag from global trade uncertainty and energy costs. But Japan was a standout gainer at 1.26%, likely benefiting from yen weakness making exports more competitive. South Korea's KOSPI jumped 2.74%. the single biggest equity move globally today. That outsized gain likely reflects a combination of tech sector recovery (Samsung and memory chip stocks are heavily weighted in the index) and possibly some unwinding of recent heavy selling, though the move seems disproportionate to any single catalyst.

Europe was also mixed. The FTSE gained 0.69%, likely helped by its heavy energy and commodity weighting benefiting from the Iran risk premium. But the DAX fell 0.56% and the Euro Stoxx 50 declined 0.70%, with Germany's export-heavy economy more exposed to global trade disruption. The clean "Europe up, Asia down" story from earlier this week is muddying.

One surprise: Mexico's IPC index gained 1.59%, making it one of the strongest global performers. In a week dominated by tariff threats, Mexico's rally is worth noting. it could reflect optimism about nearshoring trends or simply a technical bounce, but it's an interesting counterpoint to the tariff anxiety narrative.

Gold, Bonds, and the Volatility Read

Gold continues its remarkable run, with UBS noting that while the bull run faces hurdles, "the finish line is not necessarily in view." In plain English, UBS thinks gold can keep climbing even though it's already at elevated levels. In a world of war, tariffs, and 4.2% inflation forecasts, it's hard to argue with that assessment. Gold is doing exactly what it's supposed to do in this environment: serving as a hedge against geopolitical and inflationary uncertainty simultaneously.

Bond yields ticked lower across the curve. The 10-year fell to 4.31% and the 30-year dropped to 4.89%. This is directly connected to the rising recession odds headline: when Wall Street starts pricing in higher odds of an economic downturn, money flows into bonds as a safe haven, pushing prices up and yields down. The soft ADP jobs number (62,000) reinforces the growth scare. Lower yields also suggest the bond market leans toward the "energy prices as demand destroyer" camp rather than the "energy prices as inflation accelerator" camp. at least for now.

The VIX fell 2.73% to 23.87. That's still elevated compared to where we were a few months ago, but the direction is down, which tells me the market is gradually adjusting to the current level of uncertainty rather than panicking about it. Think of the VIX as a measure of how nervous options traders are. At 23.87, they're cautious but not scared.

What I'm Watching Next

Three things have my attention going into the rest of the week:

The market is doing a reasonable job of absorbing a lot of uncertainty right now. the falling VIX and small-cap outperformance suggest pockets of optimism beneath the cautious surface. But I keep coming back to one question: at what point do the accumulating economic costs of the Iran conflict become too large for equities to ignore? We're not there yet. But the mortgage warnings, the inflation forecasts, and the bond market's growth concerns tell me that line is getting closer.

Stay patient, stay diversified, and I'll see you tomorrow.

This content is for educational and informational purposes only. It does not constitute financial advice. Always consult a qualified financial advisor before making investment decisions. Past performance does not guarantee future results.