• Narratives can move prices, too, influencing investors beyond “normal” market volatility

• Perceived risk can overtake actual risk when narratives dominate

• Hidden narratives can quietly steer investment decisions

Are you reacting to market volatility – or stories about it? Both can potentially steer investors off course from their long‑term financial goals without careful planning, but one is more subtle, and therefore can pose a bigger risk.

So‑called narrative risk comes in many forms, including content from social and mainstream media. That creates a threat that can be especially stealthy for otherwise sound judgment in money management. Consider market volatility: when it strikes, it’s obvious, reflecting a measurable move in asset prices. Sharp drops in the stock market are immediately evident, not to mention expected for anyone who studies financial history in the context of long‑term planning. A carefully designed diversified portfolio, rebalancing rules, and a long time horizon all assume volatility will show up.

By comparison, narratives about market volatility can be more understated and, for some investors, fly under the radar. That’s a problem: if you are not aware of narrative risk, you may not be prepared for it.

Behavioral Traps and Narrative Risk

Recent research highlights the potential for trouble. The power of financial narratives arises from the emotions they generate.

“We find investor emotions are associated with up to 52% of market returns and 67% of market uncertainty during these market crises, and provide general evidence that investor emotional dynamics may be time and context invariant,” advise the authors of “Narrative Emotions and Market Crises,” a study published in the Journal of Behavioral Finance last year.

Another recent study – “Competing Narratives in Financial Markets” – outlines how viral narratives can drive bubbles, crashes, and volatility through opinion dynamics, fueling the possibility that competing stories can create instability even without new economic information. The key takeaway: Viral stories and social media hype can be a bigger factor in changing asset prices compared with a company’s actual financial health. By simulating a digital stock market, the researchers demonstrate that when investors split into opposing groups—like “bulls” who believe a stock will skyrocket vs. “bears” who think it will crash—their social circles turn into echo chambers that fuel massive, unpredictable price swings.

When Narratives Become Market Movers

The lesson for investors is to be alert to herding behavior, a.k.a. FOMO or fear of missing out. When the crowd buys into a stock purely because a certain narrative goes viral, it may create unstable price bubbles that can violently burst the moment the crowd changes its mind.

Some researchers find that market crises are fundamentally psychological events. Because these emotional narrative cycles repeat almost identically across history, sophisticated investors should monitor mainstream financial media narratives not just for “facts,” but as a barometer for collective anxiety or denial. Recognizing when a market is heavily decoupled from fundamentals and driven by narrative‑induced emotions can help investors avoid panic‑selling during crashes or over‑buying during bubbles.

Narrative risk appears to be a growing threat as social media deepens its reach and influence among investors. And unlike traditional volatility, which is visible on a chart, narrative volatility is invisible until it has already shaped behavior. That’s what makes it so hazardous: it doesn’t attack the portfolio first — it attacks the decision maker.

When stories about markets become louder than the markets themselves, investors may start reacting to perceived risk rather than actual risk. A headline that “stocks are plunging” can trigger anxiety even if the underlying move is routine and within a “normal” range. A viral post claiming a stock is “the next big thing” can override years of disciplined planning. In both cases, the narrative (rather than the fundamentals) can become a catalyst—perhaps unconsciously—for action.

For long‑term investors, the implication is clear: managing money requires managing the information ecosystem that surrounds it. That means:

Treating narratives as data. If the emotional tone of financial news is spiking, that’s a signal that collective psychology may be shifting.

Separating noise from signal. Volatility is normal; narrative amplification is optional. Investors who can distinguish between the two are less likely to overreact.

Re‑anchoring to fundamentals. When stories become extreme, returning to earnings, cash flows, valuations, and long‑term goals provides a stabilizing counterweight.

Building behavioral guardrails. Pre‑committed rebalancing rules, automatic contributions, and written investment policies generally help neutralize narrative‑driven impulses.

The bottom line: market volatility tests portfolios, but narrative volatility tests investors. The former is built into every financial plan; the latter can quietly unravel one. In an age when stories spread faster than facts, the real competitive advantage is not predicting the next narrative — it’s refusing to be ruled by it.

• Recession odds stay low as growth outperforms crisis expectations

• TMC’s recession indicator signals resilience, not contraction, despite inflation pressures

• Stronger hiring and firming GDP keep the Fed in wait‑and‑see mode

At the start of the Iran conflict, many analysts expected US economic growth would stumble and recession risk would spike. It was a reasonable view at the time, although TMC Research noted a few days after the war started that our “Recession Probability Indicator (RPI) continues to reflect a low probability that an NBER-defined downturn has started or is imminent.” An update of the numbers suggests more of the same.

More than three months into the Middle East crisis, the American economy still looks resilient. Inflation is an ongoing threat, thanks to the supply-side energy shock that’s lifted prices. But growth has held up better than expected, and the odds appear low that the economy is on the precipice of a material slowdown, much less an outright contraction.

The TMC Recession Probability Indicator (RPI) is currently estimating that it’s highly unlikely the economy is shrinking or will soon slip over the edge. That doesn’t mean macro risks are absent – quite the opposite. Rather, RPI reports that the quantitative signals that usually flag elevated recession risk are subdued at the moment. (RPI aggregates and processes data from three business‑cycle indicators published by regional Fed banks — see here for details.)

Last week’s release of payrolls data for May aligns with RPI’s growth bias. Hiring increased by 172,000 positions last month, beating expectations by a wide margin and marking the third straight month of relatively strong employment gains. Meanwhile, the jobless rate was unchanged at a low 4.3%.

While hiring has remained relatively resilient, the majority of recent job creation has been concentrated in the healthcare and hospitality sectors, and many other industries continue to struggle. At the same time, consumer sentiment remained near record lows in May, signaling a considerable degree of unease among households.

From a top-down perspective, however, the near-term outlook remains upbeat. For example, the Atlanta Fed’s GDP nowcast for the upcoming second‑quarter economic report is on track to accelerate to a 3.3% annualized pace, according to the bank’s model (June 9). If correct, the rate of output’s increase will more than double from Q1’s 1.6% advance.

None of this should dismiss the concern that the ongoing effects from the crisis pose a threat to the economy, primarily in the form of higher inflation. The key variable is how long the conflict lasts, which will likely determine when energy exports through the Strait of Hormuz rebound to something approximating normal — a shift that would, in turn, likely cool the recent inflation surge.

Forecasting such a turn of events is extremely challenging, although that won’t stop journalists from posing the question to Kevin Warsh, the new Federal Reserve chair, who will field these and related topics for the first time at the central bank’s press conference next week.

The economy’s resilience to date will give the Fed cover for leaving interest rates steady at next week’s June 16–17 policy meeting. But the resilience also suggests a strengthening case for raising rates. If economic activity is firming at a time when inflation is heating up, tightening monetary policy is a reasonable response at some point.

Fed funds futures currently estimate low odds for a rate hike next week and at the subsequent meeting in late July. But sentiment is starting to lean into a hawkish policy pivot later in the year – an outlook that will continue to resonate if recession‑risk odds stay low.

• New research provides strong evidence that investor beliefs—not fundamentals—drive long‑term market dynamics

• Sophisticated investors tend to be contrarian, while retail investors often extrapolate past returns.

• Valuation ratios like CAPE reflect sophisticated—not retail—expectations about future returns

How do financial markets price stocks? The answer matters because it provides information for designing and managing investment strategies.

A dominant line of analysis in asset pricing argues that long-term stock market fluctuations are driven by fundamentals like time-varying risk premia. However, a new research paper challenges this understanding by modeling the market as an interaction between naive investors (whose beliefs are decoupled from fundamentals) and sophisticated investors, using a new 70-year dataset to support the findings.

A key takeaway is that shifts in valuation ratios are almost entirely driven by expected changes in investor sentiment and price mean-reversion, not by changing expectations of dividend or earnings growth.

The paper also provides more context and support for engaging in tactical tilts at times. The standard academic and industry view—rooted in the Efficient Market Hypothesis (EMH)—holds that markets are broadly “efficient,” making buy‑and‑hold, market‑cap‑weighted indexing the logical baseline. Volatility, in this framework, simply reflects “rational” investors updating expectations. The EMH has been hard to beat over long horizons, but behavioral finance has steadily shown that real‑world investing is more complicated. Markets may be efficient enough to justify indexing, yet not so efficient that tactical adjustments are entirely pointless.

A new research paper strengthens this case for periodically adjusting portfolios beyond what a simple buy-and-hold strategy implies. In Beliefs and Stock Market Fluctuations: New Evidence from the Past Seven Decades, MIT Sloan economists David Thesmar and Emil Verner analyze seven decades of data and uncover three central findings about how different investors form expectations.

Sophisticated Investors Are Contrarian; Retail Investors Extrapolate

The idea of a unified “market consensus” is misleading. Beliefs are fragmented—and often move in opposite directions. Retail investors, as shown in surveys, are highly procyclical and extrapolative: when markets rise, they assume gains will continue and their expected returns peak near market tops. Value Line analysts, who are used in the paper as a proxy for “sophisticated” investors, behave very differently. Their expectations are countercyclical: when markets fall, they anticipate higher future returns.

Valuation Ratios Reflect Sophisticated, Not Retail, Expectations

Valuation metrics, such as the cyclically adjusted earnings-price ratio (CAPE) and earnings-price (E/P) ratio, have long been known to predict long‑term returns. Thesmar and Verner show whose beliefs they actually capture. A time‑series regression of the market’s earnings-price (E/P) ratio on Value Line’s expected returns produces an R² of 65%. Low valuations tend to align with high expected returns among sophisticated investors—exactly what rational models predict. Retail surveys generally show no such relationship. A Campbell‑Shiller decomposition reinforces the point, the study notes:

• Roughly 60% of variation in price-earnings ratios stems from shifts in sophisticated investors’ expected returns.

• 0% comes from expected changes in cash flows or dividend growth.

A graphic in the study captures the point, showing that the Value Line expected returns “account for a large share of movements in valuation.”

Disagreement Drives Volume and Volatility

If sophisticated investors are closer to rational, why do bubbles and crashes still occur? Limits to arbitrage. When retail optimism surges, naive investors buy aggressively, pushing prices above fundamentals. Sophisticated investors recognize the mispricing but cannot fully counteract it due to risk constraints. The resulting expectation gap fuels trading. When disagreement between Value Line and retail investors spikes, market volume and volatility jump as the two groups trade against each other.

The authors report that retail investors at times persist in pushing prices away from fundamentals, while sophisticated investors trade against them and can forecast future returns. The historical record, in other words, supports contrarian‑leaning strategies at times. In the jargon of financial researchers, “heterogeneous beliefs matter for market dynamics,” the paper notes.

Theory and Practice

This is old news for some investors. The likes of Warren Buffett and other value investors have been profitably exploiting this behavioral gap for decades. By some accounts the Oracle of Omaha’s impressive track record is an anomaly. Thesmar and Verner’s research, however, suggests there’s a recurring behavioral risk factor embedded in the stock market that can be used for tactical tilts, even within an indexing‑first philosophy.

Markets are smart, but they aren’t flawless. While low-cost indexing remains the smartest anchor for most portfolios, this research reminds us that human nature never changes. For the indexing-first investor, that means the occasional tactical tilt may not just be a gamble—recent research increasingly suggests it’s a data‑driven response to a persistent behavioral reality.

• Hotter inflation will feature at Warsh’s first policy meeting and press conference this month

• His June 17 debut will reveal how he handles rising price pressure

• The Treasury market hints at a rate hike in the near term

Federal Reserve Chair Kevin Warsh will preside over his first Federal Open Market Committee (FOMC) meeting later this month (June 16–17). Ahead of his public debut as the top central banker, monetary policy is essentially neutral for the first time in 2½ years, according to TMC Research’s estimate. Inflation, by contrast, is trending higher, which may set up an early challenge for the newly minted Fed chief.

Fed funds futures are still pricing in a near‑certainty that the Fed will leave its current 3.50%–3.75% target range unchanged this month, but the Treasury market is sending a different message for later in the year. The 2‑year Treasury yield — widely viewed as a proxy for policy expectations — is trading just above 4.0%, moderately above the high end of the Fed funds target range and implying that a rate hike may be near.

The concern is that the recent pickup in headline inflation will soon force the Fed’s hand and trigger one or more rate hikes to offset renewed pricing pressure. The case for rate hikes has been debatable, even after the inflation jump triggered by the conflict in the Middle East. TMC Research’s Fed Funds Model has estimated policy as moderately tight, offering a degree of inflation‑fighting medicine. But that mildly hawkish bias has continued to fade in recent months and is now essentially neutral, leaving the Fed vulnerable if inflation holds at current levels or rises further.

Several measures of inflation have jumped in recent months, driven by the Middle East supply shock that has lifted energy prices. The year‑over‑year change in the Consumer Price Index (CPI) rose to 3.8% through April — a three‑year high and substantially above the 2.4% pre‑war pace in February. Core CPI, which strips out food and energy and is a more reliable measure of underlying inflation, is also edging up but remains considerably softer at 2.7%. In both cases, inflation is running hotter than the Fed’s 2% target.

Warsh’s preferred measure of inflation, by contrast, suggests that inflation is lower and stable, giving the Fed chair more leeway to argue that rate hikes are premature. In his Senate confirmation hearing in April, he said he favors “trimmed” inflation measures, explaining that they offer better signals of underlying trends.

The Dallas Fed’s Trimmed Mean Personal Consumption Expenditures (PCE) Index, for example, rose 2.4% for the year through April, unchanged from March and only slightly higher than February’s pace.

Critics push back by noting that the trimmed‑mean PCE Index was slow to react to the 2021–2022 inflation spike, and so relying on this alternative measure could set the Fed up for another delayed reaction that gives pricing pressure room to run.

The Cleveland Fed’s inflation nowcast, however, suggests the current inflation run may be peaking. Headline CPI is expected to ease modestly in June to a 3.9% year‑over‑year rate, down from a projected 4.2% increase in the upcoming May report. Core CPI, meanwhile, is on track to hold steady at 2.8%.

The question is how the 12 members of the FOMC interpret the data. The focus on June 17 will be on the first among equals for policy votes — Warsh — who gives his first press conference as Fed chair that afternoon.

His preference for trimmed‑mean inflation will be under scrutiny, and will likely be subject to questions from the press. How he defends that preference under the glare of a live press conference will offer the first real clue about the kind of Fed chair he intends to be.

• Volatility exposes investor psychology

• Behavioral biases spike precisely when discipline matters most

• Rules tend to beat emotions most of the time

Market volatility doesn’t just rattle markets—it rattles investors, which in turn exposes behavioral risk. When markets lurch and headlines turn chaotic, that’s when dormant biases like loss aversion, herding, and overconfidence can surge to the surface and quietly steer investors toward costly decisions.

In a previous essay, we outlined several steps for reviewing your portfolio strategy when market volatility spikes. That discussion assumed a rational, cool‑headed investor—an assumption that may be too generous at times, especially during market downturns. As a complement, let’s consider the behavioral dimension during periods of market turbulence, focusing on the key risks to be aware of.

There are many behavioral-related hazards, but five stand out as especially dangerous during market corrections and bear markets. Maintaining discipline during elevated financial stress—and resisting emotionally-driven decisions that can derail long‑term goals—is never easy, but it’s always essential.

The research is clear: the costliest mistakes happen when emotions masquerade as insight. In that sense, volatility doesn’t cause those errors—it reveals them.

It’s also fair to say that behavioral risk in investing is a persistent challenge. Markets evolve, but human nature is remarkably consistent, as a recent study suggests (“Behavioral Finance in the Sphere of Investment”). The analysis reviewed 30 studies published between 2020 and 2025 that examined behavioral finance and its influence on investment choices. “The results indicate that investor psychology continues to play a dominant role in financial decision making, with biases shaping investment behaviors across different economic and technological contexts,” the authors report.

The first step in playing defense is recognizing the behavioral traps that can surface in turbulent periods. Here are five to keep on your radar.

Loss Aversion (The Pain of Drastic Drops)

Psychologically, the pain of losing money is roughly twice as intense as the joy of making the same amount. When volatility strikes, this asymmetric pain can trigger a survival instinct, tempting investors to “stop the bleeding.”

The key risk: Selling assets at or near the bottom of a drawdown in pursuit of emotional relief, turning temporary paper losses into permanent capital destruction.

To be clear, selling may be reasonable, even in a downturn. But reducing exposure to risk assets because of a predetermined set of rules may be quite different from selling because you’re triggered by news headlines.

Recency Bias (Extrapolating the Present)

Human brains naturally overweight recent events when forecasting the future. In calm markets, we assume smooth sailing indefinitely; during a sharp correction, it’s all too easy to let the darker angels of your brain assume that the downward trend will continue straight to zero.

The key risk: Forgetting the long‑term historical data on market cycles and regime shifts. This bias makes it especially difficult to maintain a rebalancing schedule, which inherently requires buying assets that have recently performed poorly, and paring back on the strongest performers.

Herding Behavior (Following the Crowd)

When uncertainty peaks, looking to the crowd for validation is a natural human response. If the financial press and broader market are panicking, individual investors often find it difficult to stand firm or look for value.

The key risk: Joining the stampede out of an asset class just as expected risk premiums are rising and prospective long‑term returns are improving.

Action Bias (The Urge to “Do Something”)

During an economic or market shock, sitting still can feel like negligence for some investors. This drive to take control can lead to over‑trading during the worst possible macro environments.

The key risk: Tweaking asset‑allocation models mid‑crisis, over‑hedging after the volatility spike has already occurred, or constantly shuffling positions. This behavior racks up transaction costs, creates tax drag, and typically results in whipsawing the portfolio. Once again, carefully developing an investment strategy before a shock, and sticking to the plan, can be a guardrail.

Information‑Avoidance Bias (Ignoring Negative or Discomforting Data)

This is the opposite of action bias: Some investors manage stress by disengaging entirely—a pattern often referred to as the “ostrich effect.” They stop checking performance metrics, ignore risk reports, and delay necessary portfolio maintenance.

The key risk: Missing critical rule‑based rebalancing windows or overlooking a fundamental shift in macro indicators that genuinely requires a programmatic adjustment to a tactical model.

• A spike in volatility is a reminder to revisit your investment plan—does it still match your goals?

• Rely on process — asset allocation, rebalancing, and tax-loss harvesting

• Look for opportunities to swap into lower-cost ETFs when harvesting losses

Bond yields are rising again, and some pundits say that the spillover could start to pressure stocks.

In moments like these, it’s easy to feel the temptation to retreat into cash, overhaul your portfolio, or chase whatever seems safe. But those impulses carry their own risks, and can potentially knock long‑term plans off track.

A better way to navigate periods of market stress is to treat volatility as a prompt to reassess and reinforce the parts of your strategy that actually drive long‑term results—while reducing the short‑term behavioral risks that can quietly undermine them. When markets turn rocky, these five forecast‑free tasks are worth revisiting to help keep your investment plan moving in the right direction.

Asset Allocation

Reassessing your asset‑allocation plan during periods of market stress is a practical way to make sure your portfolio still reflects your goals and your true tolerance for risk. Volatility has a way of exposing whether your mix of stocks, bonds, cash, and other assets is still aligned with your long‑term strategy—or whether market moves have quietly pushed you off target. Taking a fresh look at your asset allocation plan also gives you a clearer read on how comfortable you really are with your current level of risk when conditions get bumpy.

This isn’t about reacting to headlines or trying to time the next move. It’s about confirming that your allocation still fits your objectives, time horizon, and capacity to stay invested through uncertainty. The value proposition is straightforward: a well‑aligned asset‑allocation plan helps reduce emotional decision‑making and keeps your long‑term strategy intact when markets are most distracting.

Rebalancing

Rebalancing becomes especially valuable during periods of market stress, when asset prices move sharply and portfolios can drift away from their intended mix. Volatility can create meaningful gaps between your target weights and the actual holdings, leaving you either unintentionally overexposed to risk or too conservative at precisely the wrong time. Revisiting your rebalancing plan in these moments helps ensure your portfolio stays aligned with your long‑term strategy rather than the market’s latest swings.

The goal isn’t to react to every bump in the market, but to use volatility as an opportunity to realign your portfolio in a disciplined, tax‑aware way. Systematic rebalancing helps you trim what has become too large, add to areas that have lagged, and maintain the risk profile you intended. The agenda is clear: a consistent rebalancing process keeps your strategy on course and reduces the odds that short‑term turbulence will push you into decisions that undermine long‑term results.

Tax-loss Harvesting

Here’s another area worth revisiting when markets turn volatile. Sharp declines can create potential opportunities to realize losses in a controlled, intentional way—allowing you to offset current or future capital gains, reduce your tax bill, and reinvest the proceeds in similar exposures without disrupting your overall strategy. Periods of stress often widen the gap between winners and losers, making it easier to identify positions that can be harvested without compromising long‑term goals.

The value of this approach is straightforward: thoughtful tax‑loss harvesting turns market turbulence into a tangible benefit, improving after‑tax returns while keeping your portfolio aligned with its intended risk profile.

Use Tax Losses to Move Into Lower‑Expense ETFs

Periods of market stress often create opportunities to harvest tax losses, and those same moments may present opportunities for upgrading the underlying building blocks of your portfolio. When you sell a fund to realize a loss, you may be able to reinvest the proceeds in a similar—but not “substantially identical”—ETF with a lower expense ratio. This keeps your market exposure intact while reducing the ongoing cost of holding the position. (It is best to consult current IRS guidance and a tax adviser regarding wash sale rules and other tax considerations associated with tax-loss harvesting strategies.)

The benefit of this approach may include lowering expenses, which is one of the few levers investors fully control—even small reductions compound meaningfully over time. Using tax‑loss harvesting as a chance to swap into lower‑cost ETFs can turn a short‑term setback into a long‑term advantage, and may help improve tax efficiency and reduce portfolio costs while maintaining similar market exposure consistent with an investor’s overall investment strategy and risk tolerance.

Stay disciplined with contributions and withdrawals

Periods of market stress are an ideal time to revisit how consistently you’re adding to (or drawing from) your portfolio. For savers, maintaining regular contributions—especially through automated deposits—turns volatility into a potential advantage by buying more shares when prices are lower. For retirees or anyone taking withdrawals, stress periods are a cue to review your spending rate and ensure you’re not pulling too much from a declining market.

Steady contribution and withdrawal habits help smooth the impact of volatility, reduce the temptation to time the market, and keep your long‑term plan intact when conditions are most unsettled.

None of these steps are meant to replace personalized financial advice tailored to your specific goals, time horizon, or risk tolerance. Market volatility can be a useful reminder to revisit your broader financial plan. For many investors, working with a qualified financial adviser may be the best way to determine whether these strategies make sense within the context of their individual circumstances.

• Risk tolerance shifts with markets and emotions

• Static portfolios miss these swings

• Rules and periodic reviews keep investment decisions aligned with long‑term goals

Recent research is overturning the entrenched assumption that risk tolerance is relatively stable. New evidence shows it moves far more than most investors realize, which has several implications.

For starters, asset allocation should be dynamic to some degree rather than static. Regular re‑evaluation of risk profiles is also prudent.

Understanding your true risk tolerance is essential because it determines whether you can stay invested through the market’s inevitable ups and downs. When risk tolerance is misjudged, emotions may play an oversized role, which can lead to panic selling, performance chasing, and decisions that undermine long‑term results.

Getting this right is crucial because it creates the foundation for a portfolio you can stick with, no matter what the market throws your way.

The Fluidity of Risk

A growing body of research highlights that risk tolerance fluctuates and changes with market conditions, stress levels, recent performance, and even how portfolio and risk questions are presented. The key takeaway: Investors don’t have a single, fixed appetite for risk. They cycle through different levels of comfort and discomfort depending on what’s happening around them.

If risk tolerance moves with the market, then the moments when investors feel most confident often coincide with periods when risk is highest—and vice versa. This creates a behavioral trap: taking on too much risk after strong returns and pulling back too sharply after losses.

The research suggests that managing risk isn’t just about asset allocation; it’s also about understanding how emotions, context, and market cycles shape decision‑making. For investors, the challenge is learning to recognize these shifts and building a process that keeps short‑term feelings from derailing long‑term goals.

Data‑Driven Shifts

A recent study highlights how investor comfort with risk can fluctuate as market conditions shift. Fewer than one in six US adults (16%) in 2024 said they were willing to take financial risks, down from 20% in 2021, according to the FINRA Investor Education Foundation’s 2025 National Financial Capability Study. The study also notes that only 12% of adults were relatively tolerant of risk in 2009, soon after the financial crash. By 2015, after the market had rallied for several years, that share rose to 21%.

Another study found that risk preferences are dynamic and influenced by how choices are framed for 401(k) investment accounts. The authors of the 2024 research paper report that when you strip away participation barriers (such as confusing plan menus, default options, or the effort required to rebalance), more than 90% of investors would choose to hold stocks.

In contrast, “investors in the control groups who defaulted into a money market fund (or hired under an opt‑in regime) progressively increase their equity share away from their zero‑stock default,” the researchers found. “The fact that most investors move away from the default option when it is a safe asset but stay invested in the default when it is equity suggests that, absent participation frictions, these investors prefer holding risky assets.”

Practical Takeaways

In other words, the portfolios people want may be very different from the portfolios they actually end up with. If you prefer that your portfolio aligns with your real goals and risk preferences, you must actively overcome the frictions that push you toward inaction or misguided choices. Default options, old allocations, and “set‑and‑forget” choices can quietly steer you into a portfolio that doesn’t match your intentions.

Another line of analysis demonstrates that risk profiling should not rely on a one‑time questionnaire, but instead should be a continuous behavioral assessment. The paper advises: “Our findings indicate a better performance through financial returns for investors who answered behavioral finance questions and a higher retention for that group of investors with their financial advisor(s).” Risk, the author writes, “is never constant because it is shaped by both internal and external factors.”

For investors, the first step is recognizing that fluctuating risk tolerance is normal. Feeling more cautious after a market decline doesn’t mean you’ve suddenly become a conservative investor. These views may be emotional responses to recent experience and not reflect durable shifts in your financial identity.

Building guardrails can prevent temporary feelings from driving permanent decisions. This can take several forms, including:

• Defining rebalancing rules in advance

• Regularly reviewing investment strategy

• Assessing whether discomfort reflects a true change in goals or simply a reaction to market noise.

Financial advisors can play a critical role in this process. By helping clients distinguish between emotional shifts and structural changes, advisors can prevent the most damaging behavioral mistakes.

Markets, emotions, and life circumstances change. A resilient investment plan acknowledges this reality and builds in rules to keep short‑term feelings from overwhelming long‑term objectives.

• A reality check awaits the incoming Fed chair with tomorrow’s consumer inflation report for April

• Headline inflation stays hot while core and trimmed measures are relatively stable

• Inflation’s split signals complicate Warsh’s debut

By James Picerno | The Milwaukee Company

No one will be watching tomorrow’s update on US consumer inflation for April more closely than Kevin Warsh, who is expected to become chairman of the Federal Reserve this week following the Senate’s vote to confirm him.

The honeymoon may be short. Economists are forecasting that inflation will continue to accelerate at the headline level. The consensus estimate calls for a 3.8% year‑over‑year increase in the Consumer Price Index (CPI), according to Econoday.com — up from 3.3% in March. If correct, it will mark a second straight month of sharply rising pricing pressure, lifting the annual pace to a three‑year high.

Hotter inflation creates a challenge for Warsh, who has recently said that interest rates are too high — comments that have persuaded some observers that his hawkish reputation is softening. But the argument that rate cuts are prudent has become harder to make at a time when the energy shock from the war in the Middle East is driving up headline inflation.

In recent Senate testimony, Warsh recommended that the Fed refocus on the “trimmed averages” of inflation, which exclude outlier data and therefore offer a more robust profile of the trend. Notably, the Cleveland Fed’s Trimmed‑Mean CPI (T‑CPI) is running well below the Fed’s preferred inflation measure, the core Personal Consumption Expenditures index (core PCE), which excludes food and energy prices.

T‑CPI rose 2.6% for the year through March, matching the year‑over‑year gain in core CPI. By contrast, core PCE is running substantially hotter, at 3.2%, which is raising alarms in some circles that the Fed may soon need to hike rates.

The core PCE update will arrive at the end of May, but tomorrow’s CPI data may offer a preview. If economists are right, core CPI will edge up only slightly to a 2.7% increase versus the year‑ago level. The Cleveland Fed’s nowcast for April is a tick lower for the core reading.

Assuming those forecasts are accurate, the results may give Warsh some cover to argue that inflation is less threatening than it appears. Central bankers generally prefer core measures on the view that they offer a more reliable profile of inflation’s trend compared to headline inflation, which suffers from a higher degree of short-term noise.

The real challenge awaits in late May, when the core PCE numbers are released. The trend on this front is already running a full percentage point above the Fed’s 2% target.

It’s doubtful that Warsh will be able to persuade enough members of the Fed’s monetary policy committee to cut rates at the next meeting on June 17. Fed funds futures are pricing in a near‑certainty of no change.

Perhaps an even bigger issue to monitor is whether the new Fed chair’s views on rate cuts will evolve once he is confirmed for a four‑year term. A clue may emerge in tomorrow’s CPI report.

• Iran peace talks will dominate near‑term inflation risk through the energy channel

• Central banks are split as price pressures stay elevated and data stays hot

• Middle East stability — or renewed tension — remains the biggest swing factor ahead

A new peace proposal to end the war is reportedly under consideration between the US and Iran. Its success or failure will be a key driver of inflation risk, which has climbed since the conflict sent energy prices soaring. Even a durable end to the fighting — and a return to normal Gulf energy exports — would still leave elevated inflation pulsing through the global economy in the near term. The central question is whether hotter inflation proves temporary or persistent.

The answer will be a crucial factor for markets and the global economy in the weeks and months ahead. If price pressures stay higher for longer, the Federal Reserve and other central banks may feel compelled to tighten policy.

The Reserve Bank of Australia (RBA) decided earlier this week to start tightening policy. “As expected, developments in the Middle East are having an impact on inflation,” RBA announced. “Higher fuel prices are adding to inflation and there are indications that this is likely to have second-round effects on prices for goods and services more broadly.”

The Federal Reserve, by contrast, is widely expected to keep rates steady for now. Last week the Fed kept rates unchanged, and the Fed funds futures market expects the central bank will stand pat for the rest of the year.

Incoming data may be the final arbiter, starting with next week’s April CPI report. Headline inflation jumped to 3.3% in March — a two‑year high — and economists expect the 3%‑plus trend to continue, running well above the Fed’s 2% target.

The Cleveland Fed’s inflation nowcast also sees prices remaining sticky. The regional Fed bank estimates that headline CPI’s annual pace will heat up to 3.6% in April and 3.9% in May.

Markets tend to price geopolitical risk asymmetrically: escalation premiums build quickly, but they unwind only when investors believe a durable resolution is plausible. A credible peace framework would therefore have immediate implications for inflation expectations, especially through the energy channel.

The Federal Reserve is watching these dynamics closely. While policymakers do not react to geopolitical events directly, they do respond to the inflation expectations channel. A meaningful decline in energy‑driven inflation expectations would strengthen the case for future rate cuts, whereas continued uncertainty could keep the Fed cautious. The trajectory of the Iran conflict—and the credibility of any peace proposal—has become intertwined with the central bank’s policy outlook.

One sign of tentative optimism: the Treasury market’s implied inflation forecast has eased from its recent spike, with the 5‑year breakeven slipping to 2.58% (May 6) after peaking at 2.72% earlier this week.

Inflation’s path, however, will be shaped by far more than geopolitics. Wage growth, productivity trends, supply‑chain normalization, housing costs, consumer spending, and financial‑market conditions all influence how price pressures evolve. Layer on top the uncertainty surrounding global trade and fiscal policy, and the Fed faces a landscape where no single indicator can dominate the outlook.

Yet one factor stands above the rest in the near term: the trajectory of the Middle East conflict. Energy markets remain the fastest transmission channel for geopolitical shocks, and any shift toward peace — or renewed instability — would quickly ripple through oil prices, inflation expectations, and ultimately the Fed’s reaction function.

In an already crowded field of economic risks, the presence or absence of a credible peace framework is likely to exert the strongest influence on how inflation evolves in the months ahead.

• History leans toward resilience for equities after rate surges

• Forward 1‑ and 2‑year returns skew positive across many yield‑spike scenarios

• The first 3–6 months carry the most noise, making short‑run equity reactions highly path‑dependent

Inflation worries triggered by Middle East turmoil continue to hang over the global economy and financial markets. Economists are still debating whether hotter inflation driven by surging energy costs will persist or fade quickly once the conflict ends. The outcome may have implications for the US stock market.

The ongoing rise in Treasury yields is sharpening the focus on how equities might react to higher inflation. During Monday’s trading session, the 10‑year yield climbed to 4.44%, the highest level since the initial spike in late March. If the benchmark rate exceeds the war‑related peak of roughly 4.80% on Mar. 27, the move could signal a new phase for the bond market as investors demand a higher risk premium for fixed‑income securities.

To help manage expectations by studying history, TMC Research analyzed how US stocks (S&P 500 Index) have performed following run‑ups in interest rates, using the 10‑year yield as a proxy. The review covers market behavior since 1970, a period that includes several inflationary episodes. The common assumption is that equities routinely suffer when inflation heats up and interest rates rise. But a quantitative look at the historical record tells a more nuanced story, as shown in the chart summarizing the distribution of stock‑market performance over various time horizons following yield spikes.

There are many ways to test how the S&P 500 reacts to sharp increases in the 10‑year yield, but the chart above reflects one specific framework. The analysis uses monthly data to reduce short‑term noise and focuses on relatively large yield increases—defined as instances when the 10‑year yield jumps sharply relative to its lowest level over the prior six months. The S&P’s subsequent performance is grouped into four horizons: 3 months, 6 months, 1 year, and 2 years.

Within each horizon, the distribution of S&P outcomes is further divided into four buckets based on the size of the yield increase: 50, 100, 200, and 300 basis points.

For example, the blue bar in the upper‑left panel shows the range of S&P returns for the 3‑month window following a 50‑basis‑points or larger yield increase. The horizontal blue line marks the median return (2.5% in this case). The box represents the interquartile range (25th to 75th percentile), highlighting the most frequent outcomes. The vertical whiskers show the outliers—the most extreme performances.

For more context, each bar includes a sample‑size label (“n”). In the 3‑month, +50‑bps example, the sample size is 62. As the size of the yield increase rises, the sample size falls, reducing statistical reliability.

The “n” counts also reflect a 6‑month exclusion window to prevent a single, ongoing yield surge from generating multiple signals in quick succession.

In short, the analysis relies on a specific set of rules. Changing the rules will change the results, but the profiles above offer a useful first approximation for estimating how the stock market might respond if Treasury yields continue to rise.

The main takeaway: equities tend to be relatively resilient after yields rise. There’s no guarantee the future will repeat, but history suggests that yield spikes off cyclical lows have more often marked periods of equity strength rather than stress, especially over 6‑ to 24‑month horizons.

The caveat is that every event is unique, driven by different circumstances. That’s worth considering in the current climate, when the Iran conflict is injecting a geopolitical risk premium into energy markets and threatening to amplify inflation pressures in ways that may not align neatly with historical patterns.

• Market volatility reveals an investor’s true risk tolerance

• Behavioral biases often distort how much risk people think they can handle

• Use market drawdowns as diagnostic feedback to assess true risk tolerance

Thinking about risk tolerance may be an afterthought for some investors, but it’s a crucial component. The reason: a key part of investing success is ensuring that an individual owns a portfolio that’s appropriate for a given risk tolerance.

Identifying a suitable risk tolerance can be tricky because what an investor thinks he can endure in theory may not be realistic in practice. That’s a problem because a mismatch can lead to panic selling at or near market bottoms.

The recent market volatility has been a useful stress test for gauging how someone reacts under pressure—panic, patience, or something in between. Monitoring reactions during market corrections may provide a more accurate read on the capacity to handle downturns compared with questionnaires and other efforts to quantify investor behavior.

In other words, market volatility is more than short‑term noise to be endured. It’s also a diagnostic tool that can reveal the degree of emotional resilience and decision‑making under stress.

Consider the drawdown history of the S&P 500 Index, proxied in the chart below by the SPDR S&P 500 ETF (SPY). The latest selloff, following the start of the war with Iran, left the S&P down nearly 9% from its previous high. The drawdown in the spring of 2025, during the tariff‑related decline, cut the market even deeper—a 19% peak‑to‑trough drop at one point. Observing behavior during these events offers an opportunity to determine an investor’s true level of risk tolerance.

Market declines can get much worse, as the 2008 crash reminds. During that event, the S&P fell nearly 52% from its previous high.

Volatility is a feature, not a bug, of financial markets, which highlights the potential for trouble if investors overestimate their risk tolerance. That’s a non‑trivial issue because everyone suffers from various behavioral biases, according to numerous studies over the years. Examples include overconfidence bias (investors overestimate their abilities and knowledge), herd mentality (mimicking the actions of a larger group), and loss aversion (investors experience a deeper emotional impact from losing vs. winning the same amount of money).

The challenge is compounded because researchers have documented a gap between what investors say about risk perceptions and how they behave.

The good news is that there are various strategies for managing risk so that an investor’s portfolio aligns with her risk tolerance, which can be expressed as a subjective, psychological willingness to lose money. A foundational approach is building a globally diversified portfolio and structuring the asset allocation to match the investor’s risk tolerance, time horizon, and other factors unique to that person.

Developing a rebalancing plan and working with a financial advisor can also help.

In the end, volatility doesn’t just test portfolios—it tests people. Investors who treat these episodes as feedback rather than failure gain something far more valuable than short‑term returns: a clearer understanding of the risk they can truly live with.

• Markets expect the Fed to hold its target interest rate steady, but inflation risk from the energy shock is rising

• Bond yields are edging higher, hinting at early pricing of renewed inflation pressure

• Powell’s final meeting comes as Warsh prepares to take over amid growing policy uncertainty

Markets are pricing in a near-certainty that the Federal Reserve will leave interest rates unchanged at Wednesday’s policy meeting, but the high‑confidence forecast for standing pat belies the challenges that lie ahead for the central bank.

The main uncertainty that will lurk over policy decisions in the months ahead is the threat of higher inflation triggered by the supply‑side energy shock that’s reverberating from the Middle East conflict.

Fed funds futures are betting that the path of least resistance is to do nothing, for tomorrow and beyond. The implied odds for policy through the end of the year favor keeping the Fed’s target rate steady at 3.50% to 3.75%. The question is whether that’s a reasonable forecast if inflation pressures continue to build due to elevated energy prices.

The effects of the war are already conspicuous in the March report for the Consumer Price Index (CPI), which shot up to a 3.3% annual increase—a sharp change from 2.4% in February. Markets are bracing for a repeat performance in the April update, and possibly an even higher pace, in the wake of an ongoing shutdown of energy exports from the Middle East.

TMC Research’s Fed Funds Model still estimates that the policy stance is modestly tight, which may give the central bank cover to argue that leaving rates steady is reasonable while inflation concerns linger. But as today’s update of the model shows, the hawkish bias has faded lately. The current reading indicates that the actual Effective Fed Funds Rate is roughly 35 basis points above the estimated optimal level for the target rate. That’s near the lowest degree of hawkish tilt in more than a year — far below the 120‑basis‑point spread as recently as September 2025.

The argument in favor of doing nothing at tomorrow’s Fed meeting—and for some time after—is that the inflationary effects of the war (and the subsequent stalemate that’s restricting Gulf energy exports) are unclear. Although most forecasters expect higher inflation in the near term, economists are debating how long the run‑up in pricing pressure will last, and how forcefully the Fed should react, if at all.

The risk is that the central bank repeats the mistake of responding too slowly to the 2021–2022 inflation spike. Critics are quick to note that even before the war with Iran started on Feb. 28, the Fed hadn’t fully repaired the damage from the previous price surge, as shown by year‑over‑year inflation running above the 2% target in recent years.

But if inflation risk is rising, presumably the bond market would be reacting by demanding a higher yield premium. Treasury yields have increased since the conflict started, but the increase has been moderate and has yet to break decisively higher.

The benchmark 10‑year yield, for example, continues to trade in a middling range relative to the past year or so, closing at 4.35% as of Monday’s close. But as the chokehold on Middle East energy exports continues, inflation pressure is still on a path to rise.

One sign that the bond market is beginning to price in elevated inflation risk: the 10‑year yield trades close to the upper range of one standard deviation from the mean for the current rate vs. its 200‑day average. For now, the 10‑year rate is holding in a “normal” range, indicated by the grey zone in the chart below. If the market lifts the benchmark rate closer to the upper level of this range, that shift would suggest that investors are becoming anxious.

An added twist: tomorrow’s decision on interest rates will be the last for Fed Chair Jerome Powell, whose term ends next month. His pending replacement, Kevin Warsh, is back on track for confirmation after Republican Senator Thom Tillis on Sunday ended his opposition to the nominee. Because of the GOP’s thin 13‑to‑11 majority on the Banking Committee, Tillis’s vote is crucial to advance a vote on Warsh to the full Senate.

Warsh is expected to push for rate cuts after he takes the helm at the Fed next month, or so his recent comments suggest. But with surging energy costs threatening to keep inflation higher for longer, it’s unclear if he can persuade enough hawks at the Fed to ease rates and potentially create conditions that lead to another policy mistake.

For now, the Fed can stand still; the question is whether the economy will let it in the months ahead.

• The price of oil has come to be widely recognized as a valuable real‑time gauge of Iran‑war risk

• Moves toward either price extreme since the war started would signal a shift in macro expectations

• Stability near the midpoint implies investors see the status quo holding—for now

Tensions between the US and Iran remain elevated as a fragile ceasefire holds, but the war’s trajectory is still highly uncertain. Assessing risk in real time is difficult given how quickly conditions on the ground are evolving. One practical way to monitor sentiment and expectations in this environment is to track how crude oil trades relative to its history since the war started on Feb. 28.

Markets are imperfect, but shifts in oil prices tend to reflect a global, real‑time synthesis of information related to the conflict. The supply-side energy shock remains the war’s primary transmission channel, with disruption of oil and gas exports through the Strait of Hormuz driving the key macroeconomic and financial‑market risks for the global economy. Pricing this risk through oil offers a first‑order approximation of how investors are interpreting the conflict’s shifting contours.

Oil, in short, functions as a risk indicator—capturing sentiment about the war and the implied level of threat it poses for the global economy. A useful starting point is to frame the risk in terms of the range of oil prices since the attacks began on Feb. 28.

Using the US benchmark (West Texas Intermediate), prices have traded between roughly $70 and nearly $120 a barrel. The current level—around $97 (as of Apr. 23)—is near the midpoint of that range.

A significant move away from this middle zone toward either extreme, particularly over a period of days or weeks, would likely signal a meaningful shift in expectations about the war’s path. Such a move would also carry implications for the outlook on inflation, economic growth, and broader macro conditions.

For now, oil’s relative stability near the center of its war‑era range suggests that global investors expect current conditions to persist. The key development to watch is a decisive break—up or down—from this middling zone, which could reflect a material change in the conflict’s macroeconomic implications relative to the current outlook.

Ultimately, this framework deserves close attention because it distills a complex, fast‑moving conflict into a single, market‑based signal that captures how global investors are repricing risk in real time. Oil may not tell the whole story, but it reliably reflects the channel through which the war is most likely to affect macro conditions generally in the weeks and months ahead.

As long as the Strait of Hormuz remains a potential flashpoint, tracking crude’s price within its post-Feb. 28 range offers investors a clear, disciplined way to monitor whether the macro narrative is shifting—and how quickly those shifts may ripple through markets and portfolios.

• CAPE signals elevated valuation for the stock market, but a shorter-term measure suggests conditions remain “normal”

• Divergent signaling reflects differing methodologies and limits of single‑metric views

• Current conditions imply that traditional valuation measures may not be the main driver of near-term market risk

Stock market corrections may look similar from a top-down perspective of falling prices, but different factors can trigger corrections and bear markets at different times. High market valuation is a possible warning lately, but a markets‑based estimate suggests risk is lower than an accounting-based review of equities indicates.

There are multiple ways to measure valuation for stocks, and so conflicting signals are possible—if not likely—at times. Current conditions highlight the divergence. Consider the Shiller PE Ratio, a widely followed measure of market valuation. The Cyclically Adjusted Price‑Earnings Ratio (CAPE) is lofty and close to its highest level in decades, based on the April estimate from Professor Robert Shiller’s data. On that basis, stocks look substantially overvalued.

By contrast, TMC Research’s Excess Return Oscillator (ERO) for the S&P 500 suggests that the market remains in a “normal” range, as indicated by the gray zone in the top chart below. (Our previous ERO update was published in January.)

The sharp difference between the two indicators can be explained by methodology. Whereas CAPE reflects the S&P 500’s price relative to the average of real (inflation‑adjusted) earnings over a rolling 10‑year window, ERO compares the S&P’s rolling 5‑year return to its rolling 5‑year median, with results reframed as z‑scores indicating how many standard deviations returns are above or below the average on a rolling 5‑year basis.

Each valuation estimate has a distinct set of pros and cons, although both share the standard caveat that neither metric can reliably predict the market’s future performance, especially in the short term. That said, ERO’s long‑term history suggests that when the indicator moves toward or exceeds a +1 reading, the odds rise for a relatively significant near‑term top.

ERO’s current reading reflects market conditions in a “normal” range. That doesn’t mean market risk is nil. Rather, the ERO profile suggests that downside risk appears more likely to come from other sources than valuation in the current macro climate.

Debate rages, of course, over what defines a reasonable valuation these days. For example, bulls argue that artificial‑intelligence‑driven opportunities have raised the premium investors should be willing to pay for a given level of corporate earnings. ERO is agnostic on this point, but coincidentally the metric seems to favor an AI‑based analysis.

Ultimately, measuring market conditions and how they relate to “fair value” requires looking beyond a handful of indicators. Meanwhile, ERO’s current level suggests that a tactical view of valuation doesn’t look threatening.

Encouraging, perhaps, but with a number of other risks lurking—including elevated geopolitical dangers—ERO should be used as an initial measure of market risk rather than the last word on what factors could weigh on investor sentiment in the near term.

• Redemptions are rising and managers are starting to limit withdrawals

• Software‑linked lending is flashing stress signals

• A sharp jump in Treasury yields could trigger more outflows

Private credit has gone from a niche backwater to an increasingly mainstream allocation, but investors are discovering that its headline attraction — lofty yields — may come with real, often underappreciated risk.

Minds have become more focused on the risk aspect lately as questions about the viability of the market come under critical scrutiny. In years past, worries about private credit could be ignored by most investors, but the industry for lending by private equity firms has boomed, especially in the post‑pandemic years. Critics are now asking whether this former backwater is becoming too big to fail and poses a threat to the wider economy.

The value of debt financing beyond conventional borrowing channels (banks and the bond market) in the US was $1.34 trillion in 2024, roughly five times higher than in 2009, according to the Federal Reserve. Some estimates now peg the figure above $3 trillion-plus in 2026.

A Boom That’s Finally Drawing Scrutiny

Few observers saw the growth of alternative lending sources as a problem until recently, when investor redemptions began rising sharply, persuading some managers to limit withdrawals. One trigger for turning cautious on private credit is the industry’s hefty lending to software companies, which have come under pressure lately on the view that artificial intelligence threatens their business models.

Right or wrong, a more cautious view on the outlook for software firms is reverberating back into private credit. The fear is that a stress‑driven correction in private credit, given its breadth and depth in the financial ecosystem, could create a liquidity shock on Wall Street and beyond.

Some analysts point to rising stress signals, such as an increasing default rate among US private‑credit borrowers. But in a sign that the worst may have passed, Fitch Ratings estimates that the default rate in US private credit declined to 5.4% in February, down from January’s 5.8%, the highest since August 2024.

Even if you never touch private credit, the industry is worth tracking because stress in this opaque corner of the market can transmit outward — through bank funding lines, credit spreads, and real‑economy financing — and turn a niche disruption into broader financial and economic strain. A useful starting point for monitoring sentiment is watching two ETFs that have been plying these waters.

The funds in the chart below represent two measures of the private‑credit industry. The Virtus Private Credit Strategy ETF (VPC) tracks the Indxx Private Credit Index, which is composed of US‑listed business development companies (BDCs) and closed‑end funds (CEFs) focused on private credit. The VanEck BDC Income ETF (BIZD) targets the MVIS US Business Development Companies Index, a proxy for the performance of publicly traded BDCs, which are funds that invest in small- and mid-sized companies.

Note the recent upturn in both funds, which may be a sign that the market is beginning to look through the recent turbulence. Some high‑profile observers of the market appear to be softening concerns about the risk outlook. JPMorgan Chase CEO Jamie Dimon said this week that he’s “not particularly worried” about his firm’s $50 billion allocation to private credit.

The Signals That Could Matter Most For Private Credit

A rise in interest rates could change minds, but here too the latest numbers suggest the market has steadied. The 10‑year Treasury yield, for example, has increased moderately since the start of the war with Iran, but the current 4.32% yield remains in a middling range for the trailing one‑year period. A rise above the recent peak (roughly 4.45%) could be a new warning sign.

Perhaps the critical variable is when — or if — banks dramatically pull back their credit lines, a source of liquidity that has been instrumental to date in financing new deals and managing cash flow. Those lines of credit may come under closer scrutiny if more investors try to liquidate their private‑credit holdings.

What might trigger a new round of investor withdrawals? There are many possibilities, but a sharp rise in Treasury yields is near the top of the list. That scenario may become more plausible if incoming inflation data is hotter than expected due to the supply‑side energy shock unleashed by the war.

• Inflation is rising on the energy shock, but growth indicators still look resilient

• Oil’s 50‑day average is above $80, which suggests energy risk is becoming elevated

• Fed policy is still on hold for now

Economic risk is rising as the Middle East conflict keeps energy prices elevated, but several business‑cycle indicators tracked by TMC Research suggest that the war’s negative effects remain limited for the US economy so far.

The situation remains fluid, and facts on the ground can quickly change the analysis. Current data, however, indicates that economic activity remains relatively resilient. Conditions could deteriorate, but it’s encouraging that, for now at least, the war’s blowback has yet to make a meaningfully negative impact.

Oil prices remain the critical variable. The recent spike pushed the US benchmark (West Texas Intermediate) above $112 a barrel last week, but the price quickly pulled back and remains just below $100 (as of Apr. 13). The run‑up in price volatility is worrisome, but the main risk is if oil stays elevated for an extended period. In that scenario, energy prices generally will remain high, which could trigger demand destruction and raise inflation.

The challenge is defining what counts as “elevated,” and for how long? One way to monitor the risk is by tracking the 50‑day average price of oil, a crucial input that filters through the economy. Economists debate where the tipping point lies for signaling a danger zone. A reasonable starting point is watching the rolling 50‑day price: a rise into the $80–$100 range that persists for a month would be a warning sign that energy costs are poised to threaten the economic outlook.

The 50‑day average has recently crossed above $80, suggesting that the outlook for inflation and economic activity is starting to look worrisome (red line in chart below).

The supply‑side energy shock has already lifted inflation. The Consumer Price Index (CPI) at the headline level rose to a two‑year high of 3.3% for the year‑over‑year change through March—sharply above February’s 2.4% increase. TMC Research estimates that the longer the 50‑day average stays above $80, the higher the odds that inflation will hold at current levels, if not rise further, for some period of time.

Economic activity, however, has yet to show a meaningful impact from the war so far. One example is the Dallas Fed’s Weekly Economic Index (WEI), a real-time measure which continues to reflect year‑over‑year economic growth at a mid-2% pace, based on data through Apr. 9.

TMC Research’s model for estimating US recession risk in real time still reflects a low probability that an NBER-defined contraction has started or is imminent, based on data through early April. Our US Recession Probability Indicator aggregates and models data from three business-cycle indicators published by regional Fed banks (see here for details).

Market expectations are still anticipating that the Federal Reserve will leave its target rate unchanged for the foreseeable future, based on Fed funds futures. That suggests the debate remains open about the severity of the inflation threat.

Several policymakers at the central bank are considering that rate hikes may be needed to counter inflation, according to the minutes of the March 17-18 meeting. “Some participants judged that there was a strong case for a two-sided description of the [Federal Open Market] Committee’s future interest rate decisions in the post-meeting statement, reflecting the possibility that upwards adjustments to the target range for the federal funds rate could be appropriate if inflation were to remain at above-target levels,” the minutes said.

TMC Research’s Fed Funds Model estimates that monetary policy continues to reflect a modestly hawkish bias. That stance may give the central bank time to determine whether the war‑driven increase in inflation is temporary or requires a new round of rate hikes. For now, keeping policy steady appears to be the more likely path.

Oil remains the critical variable in the near term. The latest sentiment on Wall Street leans toward cautious optimism that a peace deal with Iran is still possible following failed negotiations over the weekend and Monday’s implementation of a blockade of maritime traffic to and from Iran’s ports.

“I can tell you that we’ve been called by the other side,” Trump told reporters on Monday. “They’d like to make a deal very badly. Very badly.”

The war hasn’t broken the cycle yet. Whether it stays that way may depend on how long oil prices stay elevated. The economy can absorb a lot, but the clock is ticking. If oil keeps grinding higher, the pressure may reach a tipping point.

• Managing behavioral risk should be a top priority for most investors

• Psychological factors can meaningfully shape investment decisions

• Designing portfolios that help investors live with market volatility is essential

Risk management matters for several reasons, but it starts with a simple fact: investment losses don’t always behave symmetrically.

This mismatch threatens to weaken an otherwise sound investment plan because behavioral risk can spike when markets decline. In those periods, the average investor is prone to letting emotions drive ill-timed decisions that can have adverse effects on portfolio performance for years.

For most investors, there’s a strong case for managing portfolios in an effort to soften the periodic volatility spikes that are part of the normal ebb and flow of markets through time.

There are several reasons why developing portfolio strategies can help cushion short-term declines, which can trigger behavioral mistakes. A review of the math tells the story and illustrates why buy-and-hold investing can be so difficult to endure when markets hit a rough patch.

Consider the hurdle required to regain an investment loss. To fully recover from a 10% decline requires an 11% rebound. A 20% decline needs a 25% recovery, and a 30% slide is healed only after a subsequent 43% increase. As the table below shows, the math only gets uglier as losses deepen.

The chart below highlights the exponentially higher performance hurdle associated with deeper losses.

The key lesson is that while market risk can’t be avoided, it can be managed to a degree. Holding a multi-asset class portfolio is one dimension of risk management. Another is adjusting asset allocation systematically based on risk analytics, which can help minimize volatility spikes relative to a passively managed strategy.

Although risk can’t be completely avoided when investing, it is possible to reduce the odds of enduring the deepest losses that are mathematically and behaviorally difficult to recover from. The wisdom of using risk management isn’t only about outperformance, although that can be part of the strategy agenda. No less important is preparing for the emotional response that can arise during the deepest market drawdowns.

Numerous research studies over the years find that investor psychology can be a key factor in portfolio performance. Although some investors can muster the steely discipline to look through bouts of market volatility and focus on the long run, such restraint is generally rare.

The average investor, by contrast, may be vulnerable to an array of behavioral biases—fearing losses more than enjoying gains (loss aversion), following the crowd (herding), and overestimating skill (overconfidence), to name a few. Developing an investment strategy to help manage these risks is a critical input for tipping the odds in favor of achieving long-term financial objectives.

To the extent that risk management can help mute volatility spikes, it lowers the odds of emotional decisions that can disrupt long-term plans.

• TMC Research’s markets-based estimate of Iran War risk still indicates an elevated risk regime

• The surge in oil prices is the main driver of heightened risk expectations

• Additional factors that are raising risk perceptions: credit spreads, stock market volatility, inflation, and the US dollar

The war with Iran continues to roil financial markets. At some point the risk will peak, providing context for deciding if the worst has passed. Estimating that point will be useful but also challenging in real time, in part because it’s a task that requires analyzing a wide variety of data. As a first approximation, TMC Research is tracking an aggregate of five relevant risk dimensions based on market signals via a set of ETFs.

There are several ways to estimate war-related risk through a markets-based lens. TMC Research’s Iran War Risk Index (IWRI) represents an initial estimate of war-related perceptions. This model can easily be updated in real time for tracking how markets are reacting to news events. Short-term changes can be noisy, and so the daily data are smoothed with a LOESS regression model to highlight the trend.

IWRI is comprised of five inputs that are germane for monitoring the war. ETFs are used as proxies for each variable:

• Crude oil (USO)
• US dollar (UUP)
• Stock market volatility (VIXY)
• Credit spread (IEI–HYG spread)
• Inflation risk sentiment (TIP–IEF spread)

The weights of the five factors are slightly skewed relative to an equal weighting and give oil the highest weight (30%), followed by 25% for the credit spread, 20% for the US dollar, 15% for stock market volatility, and 10% for inflation risk.

The current reading continues to show an elevated level of risk, as of Apr. 6. The data are shown in z-scores, and so levels above +1 equate with high risk. Accordingly, a drop from the current level below +1.0 may be an early clue that markets are starting to price in de-escalation. Such a change in sentiment, for now, doesn’t look imminent, with IWRI trading above +2.0, which is far above the pre-war range.

A sustained decline in IWRI toward its prewar range would be a sign that markets see the danger fading. Until then, elevated readings suggest that a high-risk narrative remains in play.

• Oil’s rise is adding to recession risk, but history suggests the signal remains mixed

• The US is less sensitive to energy shocks than in past cycles

• The war’s impact on global supply and sentiment in the weeks ahead will determine how much risk ultimately materializes

Oil has been a central pressure point in most US economic downturns of the post‑WWII era, but not every spike in the commodity automatically leads to a recession.

Higher oil prices clearly raise economic risk, largely because crude is a primary feedstock, influencing a wide range of products, services, and prices. A sharp rise in energy costs tends to ripple across the economy. But the effects vary, depending on the economy’s strength at the time of the price jolt, prevailing financial conditions, and how long the surge lasts.

The risk from an oil shock can be significant, although the potential for blowback is lower than in previous decades. One reason: the US is less vulnerable than many other countries because America pumps more oil than it consumes. Another advantage: lower energy intensity. The amount of oil needed to generate a given unit of GDP has fallen sharply in recent decades.

Lower risk isn’t zero risk, however, in part because oil is priced globally, as TMC Research discussed earlier this month. That means higher energy costs stemming from disruptions in Middle East exports will spill over to the US to some degree.

Gauging how much of a shock the economy will absorb is challenging because the medium‑term effects of several key variables remain unknown. At the top of the list: How long will the war last, how quickly will Middle East exports rebound toward normal levels, and how will US consumers and businesses respond in the interim?

What we do know is that previous oil spikes don’t always line up with recessions. Consider the year‑over‑year changes in the US oil benchmark — West Texas Intermediate (WTI) — in relation to economic contractions, as defined by NBER.org, the official arbiter of the US business cycle. The key lesson: recession risk rises when oil prices rise sharply, but the relationship varies because other macro conditions matter, too. Higher energy costs usually slow growth, but to varying degrees, depending on other conditions that are unique to each point in time.

For example, following the economy’s recovery from the financial crisis in 2008 through the eve of the pandemic in early 2020, oil rose sharply relative to the year‑ago level on four separate occasions. In each case, the economy sidestepped a business-cycle recession, even if there was a price tag to some degree.

The reasons why an oil shock may or may not push the economy over the edge vary. Energy is a crucial factor for the business cycle, but conditions matter in other areas, such as interest rates, the labor market, consumer spending, and the pace of economic activity going into the spike, to cite a few examples. These and other macro factors play a role in determining how a rise in energy prices will affect growth and inflation.

It’s also worth noting that the current increase in oil — approaching a 30% year‑over‑year gain, based on prices through Mar. 23 — is a hefty change from recent history. But the increase, so far, is still well below changes associated with the three recessions prior to the pandemic, which was unusual in the extreme and therefore of limited value for studying business‑cycle behavior.

If oil prices continue to rise, recession risk will follow. But until there’s more clarity on how the economy adapts to the war’s effects and the associated run‑up in oil, there’s still room for debate over whether a US recession is inevitable.

The determining factors that will have the last word are the war’s duration and the degree to which it constrains global energy flows and influences risk sentiment in the US and abroad.

• Stocks are down, but earnings help cushion the blow

• War pressure is rising, but earnings forecasts remain upbeat

• The longer the war lasts, the greater the risk that earnings could stumble

The stock market’s decline since the Iran war started isn’t surprising, but some market observers have been puzzled by the gradual, orderly slide in equities to date. Why hasn’t the conflict triggered a deeper correction? Robust earnings may be a factor.

The S&P 500’s current drawdown is -7.2%, which is still relatively modest by historical standards. No one knows if the decline will deepen, or when the war will end, but solid earnings data is a likely reason why the correction, so far, is still within a “normal” range.

Earnings are a key—if not the primary—driver of equity returns through time, which suggests that recent gains on this front, along with upbeat expectations for the near‑term outlook, may have helped limit the downside for stocks.

The research firm FactSet estimates that the equity market’s year‑over‑year earnings growth rate through this year’s first quarter is 12.5%. “If 12.5% is the actual growth rate for the quarter, it will mark the sixth straight quarter of double‑digit (year‑over‑year) earnings growth reported by the index,” writes the senior analyst.

For recent historical perspective, consider the stock market’s performance (S&P 500 Index) in context with earnings. Unsurprisingly, equities have been rising in line with earnings growth. If the bullish forecasts for earnings are accurate, the growth trend may provide support for stocks and help minimize the war-related downside risk.

Market volatility in the short term can spike for a variety of reasons, and so it’s never clear how much support earnings can provide over a few weeks or months. As the renowned value investor Ben Graham famously observed, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.”

Wall Street remains generally upbeat on S&P earnings for 2026. The question is how much of a haircut could brewing if the war runs longer than the optimistic views suggest?

Analysts at Barclays this week wrote: “We believe the US continues to offer stronger nominal growth than other major economies and a secular growth engine in technology that shows few signs of stopping,” the bank’s strategists advised. “We are incrementally bullish on US equities, though the road likely stays bumpy until we turn a corner.”

The war is still the elephant in the room in terms of risk factors. The sooner the conflict ends, the higher the confidence that the growth trend for earnings can continue with minimal damage.

Another key variable to watch is economic growth. The Atlanta Fed’s current nowcast for the upcoming first‑quarter GDP report points to a moderate rebound in output following the sluggish rise in the fourth quarter.

If the war ends soon, and the economic headwinds from the conflict are relatively mild and short-lived, the odds will remain favorable that corporate earnings will continue to rise and provide a degree of ballast for the market in the months ahead.