Middle East turmoil: Are we now holding the "script" of the stagflation crash from 2022?

Ongoing geopolitical conflicts in the Middle East continue to disrupt markets, AI-related stocks have experienced sharp corrections, and inflation data is heating up again, causing some investors to worry about a recurrence of the "stagflation + sharp decline" nightmare of 2022. However, J.P. Morgan believes that the current situation is fundamentally different from 2022, inflation has peaked and is falling, earnings fundamentals remain robust, and market rotation rather than systemic collapse is a more accurate description.

According to Fengchasing Trading Desk, citing the latest report released by J.P. Morgan's Global Market Strategy team on July 20, the energy price shock caused by the Iran conflict is fading—Brent crude oil has fallen about 25% quarter-on-quarter, and its spillover effect has begun to dampen the overall U.S. CPI. The three-month seasonally adjusted annualized growth rate of U.S. CPI fell to 2.8% in June from 8.2% in May, while inflation in the Eurozone is also slowing. J.P. Morgan's strategist Mislav Matejka's team clearly states that inflation has started to peak, which will successively bring lower bond yields, reduced central bank hawkish pressure, and a weaker dollar, thereby widening opportunities for rotation among leading market sectors.

Regarding market impact, J.P. Morgan maintains an overall overweight stance on stocks and recommends investors use downturns driven by geopolitics as opportunities to increase holdings. The bank notes that even though AI and momentum-related stocks have seen a significant pullback, the MSCI Global Index remains within just 1-2% of its historical high, indicating overall market resilience. Early data from Q2 earnings season also provides support, with about 97% of S&P 500 constituents beating expectations, far above the 76% long-term average.

AI momentum positioning entering mature stage, semiconductors expected to bottom out

In recent weeks, AI-related stocks have seen sharp sell-offs. According to J.P. Morgan's report, the Korea Composite Stock Price Index (KOSPI) has dropped 25% from its recent high, the Philadelphia Semiconductor Index (SOX) is down 20%, and individual stocks like Samsung Electronics and Micron Technology have fallen between 20% and 50%. The Mag-7 group is stabilizing but still lagging the broader market year-to-date. The AI risk exposure basket has fallen over 20% relative to the market since the start of the year.

J.P. Morgan believes that the drivers of this pullback are both fundamental and technical. On the fundamental side, reports that Meta may sell computing power resources have triggered doubts about the sustainability of capex in hyperscale data centers; Apple is reportedly considering sourcing memory chips from Chinese suppliers, compounding worries over loss of pricing power for Korean memory firms; news of Chinese AI labs like Moonshot narrowing the technological gap with U.S., as well as LLM token price trends, have also weighed on related stocks. On the technical side, chip stock positioning indexes previously rose to their highest since 1999-2000, and excessive accumulation of momentum factors has been a major force behind the current pullback.

However, J.P. Morgan does not believe this will mean sustained market weakness.

The bank notes that SOX's relative strength index (RSI) is quickly approaching oversold territory, momentum factor excess returns have sharply reversed, and technical positioning pressure has eased. Meanwhile, the gap between the price performance and earnings performance of European semiconductor stocks is widening—stock prices have fallen sharply, but earnings expectations remain firm.

J.P. Morgan's global tech team maintains an optimistic outlook for the semiconductor sector, citing: meaningful supply increments will not emerge until 2028 at the earliest, the DRAM/NAND supply-demand tightness is expected to last till 2028, and the AI data center capex wave will continue benefitting the entire semiconductor value chain. The bank suggests investors should buy into semiconductor stocks during summer dips.

Inflation has peaked; key differences from 2022

Market worries about a "repeat of 2022" center on whether energy shocks will again trigger runaway inflation and aggressive central bank hikes. J.P. Morgan makes a systemic comparison and points out fundamental differences between now and 2022.

In 2022, U.S. headline CPI peaked at 9.1%, core CPI at 6.6%, wage growth kept accelerating, eurozone natural gas prices soared as much as 389%, the Fed hiked rates sharply from ultra-low 0.25%, and inflation expectations showed signs of de-anchoring. Now, U.S. headline CPI is about 3.5% and slowing, core CPI is about 2.6%, wage growth is slowing, eurozone natural gas prices peaked only 108%, Fed policy rate is stable at 3.75%, and scale of strategic reserve usage far outpaces 2022.

The most critical difference is inflation expectations. J.P. Morgan's data shows that the U.S. 5y5y forward inflation rate has always fluctuated within a narrow 25 basis-point range and never breached 2.60%. This contrasts sharply with the de-anchoring signs seen in 2022. The bank believes this gives central banks more policy flexibility than current market pricing suggests—markets are currently pricing in about 90 bps of Fed tightening, but J.P. Morgan considers this too aggressive and expects it will be revised downward. The U.S. 2-year Treasury yield has started to retreat from recent highs; the hawkish repricing in June may mark the high-water point for this cycle.

Geopolitical shocks show "diminishing effect", recommend buying on dips

Since the outbreak of the Iran conflict in February this year, there have been multiple rounds of escalation and easing.

According to J.P. Morgan's timeline, after the U.S.-Israel joint strike on Iran in late February, the MSCI Global Index fell 3.7% in a week and 8.6% in a month; after a ceasefire agreement in April, the market quickly rebounded; in early June, the ceasefire broke down, triggering another 3.8% weekly drop; after Trump's announcement of a permanent ceasefire in mid-June, the market's weekly loss narrowed to 0.5%. In early July, Iran was again accused of attacking ships in the Hormuz Strait, U.S. restarted sanctions and launched new strikes, but market reaction has noticeably stabilized.

J.P. Morgan believes that each round of geopolitical shocks leads to diminishing pullbacks, and the market is increasingly viewing geopolitical risks as temporary factors, especially as both sides have strong motives to de-escalate. Since the second half of March, the bank has continued to advise investors to use geopolitically driven dips to increase equity exposure and maintains this view.

Strong Q2 earnings, Eurozone earnings revisions catch up with U.S.

Early data from earnings season provides extra support for the market.

J.P. Morgan's report shows that about 97% of S&P 500 constituents that have reported so far are beating expectations, significantly higher than the 76% long-term average; Euro Stoxx 600's beat rate is also far above the historical average. More importantly, the price response of stocks beating expectations is clearly positive, both in the U.S. and Europe.

Key sectors previously favored by J.P. Morgan, semiconductors and banks, have delivered strong results. TSMC's earnings show continued order momentum and positive guidance for 2027 capacity planning; the banking sector has shown stable net interest margin income and robust investment banking income.

In the Eurozone, EPS earnings revision ratio has accelerated for 15 consecutive weeks and has for the first time since January 2025 fully caught up with the U.S. J.P. Morgan sees this improvement as broad-based—all seven top-tier sector groups show positive revision momentum, with energy and IT leading, and materials, industrials, and communication services also seeing marked improvements thanks to fiscal stimulus transmission and global trade recovery. The bank is overweighting the Eurozone in regional allocation, and believes the upward earnings trend will continue as long as the Iran conflict does not further escalate in the second half of the year.

Strategically, J.P. Morgan maintains overweight on stocks, overweight cyclical relative to defensive stocks, overweight the Eurozone versus the U.S., and views semiconductors as a tactical buying opportunity after recent corrections, while continuing to avoid software, business services and media sectors hurt by AI, and energy stocks.

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The above content is from Fengchasing Trading Desk.

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