Tim Hoyle, Chief Investment Officer
thoyle@haverfordquality.com

Market Rally Sidetracked by Middle East Conflict

The S&P 500 hit a post “liberation day” high on June 12^th, before news of Israeli strikes on Iran’s nuclear facilities and senior military personnel caused the market to trade lower. In addition to the human impact of these conflicts, markets remain sensitive to the influence on energy prices. As of this writing it doesn’t appear that Iran’s oil infrastructure has been specifically targeted, but the price of Brent Crude Oil contracts spiked 8% to close Friday at $75 per barrel, higher but below the highs of earlier this year.

If the conflict remains limited, markets may very well remain calm. However, if Iran targets U.S. assets or attempts to disrupt transit through the Strait of Hormuz, which accounts for 30% of global oil shipments, oil prices could rise significantly, leading to higher inflation. Lowering energy prices are a key part of the Trump administration’s policies to lower inflation, offset tariff costs, and encourage the Federal Reserve to lower interest rates.

While many on the Federal Open Market Committee (FOMC) still consider inflation to be a more significant threat than declining job growth, recent data on both factors may influence some opinions. Both critical economic indicators are showing a downward trend. Consumer prices showed year-over-year inflation at 2.4% while only 139,000 jobs were added in May.

The current consensus projects two rate cuts this year, with the FOMC waiting until October to begin cuts. A small move in interest rates can have a profound effect on the cost of mounting federal debt. With close to $10 trillion of debt to refinance in the next year, a 25-basis point reduction in short-term borrowing costs is equal to $25 billion of interest savings.

Setting interest rate policy may be the most visible of the Fed’s actions, yet they are also responsible for ensuring the safety and soundness of our banking and financial system. Newly appointed Vice Chair for Supervision, Michelle W. Bowman, recently delivered remarks that were well received by the industry and investors who have been hoping for a lighter regulatory regime from the Trump administration.  Bowman stated, “Banks must be able to earn a profit and grow while also managing their risks. Adding requirements that impose more costs must be balanced with whether the new requirements make the correct tradeoffs between safety and soundness and enabling banks to serve their customers and run their businesses.”

While financial stocks have performed well, the strongest sectors of the market remain those related to the AI trade. The unprecedented amount of capital expenditure planned by AI hyperscalers is driving revenue growth in all corners of the economy, from HVAC to real estate. Oracle has recently estimated they will spend 35% of this year’s revenues on capital investment to keep up in the AI arms race.

Close to home, Amazon has announced a planned $20 billion investment in Pennsylvania, the largest capital investment in the State’s history. The investment will fund the construction of two data center complexes to support Amazon Web Services (AWS) cloud computing and AI operations, one in Luzerne County and one in Bucks County. Once constructed, these data centers will consumer over 1,500 megawatts combined, or about 10% of the State’s current electrical usage.

The power needed to run current and planned data centers has grown at an unprecedented rate. As the accompanying chart illustrates, the Energy Information Administration’s estimate for incremental future power demand has more than doubled during the last four years. We believe this demand will represent a profitable investment theme for the next decade.

Despite the current geopolitical tensions and market fluctuations, there are significant opportunities for investors. The AI sector continues to drive substantial revenue growth across various industries, with major companies like Oracle and Amazon making unprecedented capital investments. Additionally, the increasing demand for power to support data centers presents a crucial investment theme for the next decade. Haverford Trust will remain vigilant and consider these emerging trends as we navigate the evolving quality investment opportunities in the markets.