CITIC Securities: Divergences and Scenarios of Middle East Conflict

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Source: CITIC Securities Research

Written by | Qiu Xiang, Zhang Mingkai, Chen Feng, Gao Yusen, Chen Zeping, Liu Chuntong

The trajectory of the Iran conflict and its market impact are highly divergent in expectations. Behind different judgments, there are three core issues currently unverified and difficult to answer: First, after the conflict intensity decreases, to what extent can maritime navigation resume? Second, does the Federal Reserve focus more on inflation indicators or on actual employment conditions? Third, is China facing cost shocks or opportunities from supply chain re-shoring? These questions may only become clearer around April. Amid great uncertainty, the market has shown some short-term trimming of positions, with previously strong-performing stocks recently falling more. Overall, most performance-driven and narrative-driven market signals have returned to the same starting line since the beginning of the year. The first three months can be seen as a market rotation driven by expectations and narrative battles during spring volatility and cooling, not the full-year winning strategy. The broader rebound in PPI, price transmission, and corporate profit recovery are the directions with both expectation gaps and room for growth this year, but the decisive moment will be in April.

The trajectory of the Iran conflict and its market impact

Significant divergence in expectations

1. “Decreased conflict intensity, timely TACO” vs. “Maritime navigation not yet restored, supply chain disruptions not fully reflected in supply.” The first view: Since the outbreak on February 28, 2026, the US and Israel have carried out targeted high-level eliminations of key military and political figures in Iran, confirmed or highly probable to have killed at least 22 individuals including the Supreme Leader, Quds Force Commander, Chief of Staff, Defense Minister, Intelligence Minister, National Security Council Secretary, and Basij commanders. This indicates a heavy blow to Iran’s central command, intelligence, and military-political coordination. This view believes that subsequent major upheavals are unlikely, and if Trump halts and withdraws promptly, TACO transactions will still hold. The second view: The Iran conflict is highly unpredictable; unless maritime traffic normalizes, market margins could be disrupted by new shocks at any time. Currently, shipping through the Strait of Hormuz remains low—on March 19, 2026, only a few ships per day pass, with no signs of large-scale reopening (pre-conflict daily average 120-140 ships). The spread between Brent crude and Dubai/Oman spot prices is large, possibly due to regional inventory buffers, pricing structure deviations, or policy interventions. If the strait remains closed, prices will tend toward Middle Eastern spot prices.

2. “Clear risk of stagflation and tightening liquidity” vs. “AI impacts employment more, making tightening difficult.” The first: Historical experience with Middle East conflicts and supply shocks suggests that even if stagflation does not develop, cost-push inflation could delay Fed rate cuts, challenging liquidity. After the March 18 Fed meeting, implied rate cuts this year remain low—0-1 times. The second: AI infrastructure investments will continue; after this conflict, countries will push for electrification and energy security (e.g., UK recently eased wind power import tariffs). Industrial demand remains strong, and the probability of global stagnation is low. However, AI agents, as powerful productivity tools, are already impacting employment—February marked a critical point for coding agents, with increasing layoffs in large firms. The combined factors make Fed policy balancing more difficult. The Fed is likely cautious, avoiding clear guidance.

3. “Prolonged conflict will heavily impact China” vs. “China’s supply chain resilience and reduced oil dependency.” The first: China relies heavily on oil imports, with a significant portion from the Middle East—about 36% of total oil imports in 2025 pass through the Strait of Hormuz. Many Asia-Pacific countries face similar issues, so ongoing conflict would significantly raise China’s energy costs, while the US is largely self-sufficient. The second: China’s oil import ratio relative to GDP has decreased from 2.2% fifteen years ago to 1.7% (around $80 per barrel in 2010 and 2024). Current reserves, including commercial and strategic stockpiles, can cover over 90 days of consumption. China’s energy diversification—coal chemical, green alcohol, and other chemical capacities—still has surplus, and renewable energy has room for absorption, potentially replacing some oil demand. China has long-term energy security strategies, with additional supply from Russia, the Americas, Africa, and Central Asia, totaling about 130 million tons annually, plus domestic production potential and strategic reserves, roughly covering the Strait of Hormuz risk exposure of 185 million tons. A more likely scenario: supply chain disruptions in Europe, Japan, and India could shift demand toward China, accelerating the alleviation of China’s overcapacity in chemical chains, similar to post-pandemic supply chain shifts.

Core unresolved questions

Currently unverified, difficult to answer

1. To what extent can maritime navigation recover after conflict intensity decreases? As of March 19, only five ships pass through the Strait of Hormuz daily (four small bulk carriers, one refined oil tanker), with no signs of large-scale reopening (pre-conflict daily average 120-140 ships). The blockade has lasted 20 days, with about 20,000 sailors stranded. Navigation shows significant “camping” features—only certain ships are permitted through specific mechanisms. According to LSEG, VLCC (Very Large Crude Carriers) daily charter rates have surged from $10-20/ton to $60-80/ton, sometimes exceeding $90/ton, reaching historical peaks. Iran has established “safe channels” within its waters, implementing conditional paid passage—ships must report owner info, cargo destination, and accept Iranian inspections; some operators paid $2 million for passage rights. Currently, over 70% of ships passing are from China, Russia, Iran, with the rest from Panama, Tanzania, Singapore, and other neutral countries; no US, Israeli, or European ships are passing.

2. Does the Fed prioritize inflation indicators or employment data? The March 2026 Fed meeting kept rates steady at 3.50%-3.75%, maintaining a hawkish stance as expected. Powell said “wait and see,” uncertain about the impact’s scale and duration, noting traditional views tend to “look through” energy shocks. TIPS implied inflation expectations for five years have only risen about 23 basis points; considering liquidity shocks, five-year inflation expectations remain almost unchanged. Employment has slowed—February non-farm payrolls declined, and December 2025 and January 2026 data were significantly revised downward. The Fed’s latest SEP removed references to “signs of stable unemployment,” reflecting concerns about ongoing weakness. As exemplified by the capabilities of coding agents like Opus 4.6 and GPT 5.3 Codex launched in early February, the impact on employment remains uncertain, though layoffs in large firms are increasing. These factors make Fed policy balancing more complex. The Fed is likely cautious, avoiding firm guidance.

3. Is China facing cost shocks or supply chain re-shoring opportunities? High-frequency data show initial transmission of spot and futures prices. Logically, supply shocks should boost profit margins in key segments, especially since China’s supply chains remain resilient. But globally, the core issue is “price without volume”—not the right timing for contrarian bets. Downstream manufacturers, before volatility subsides, worry about buying at high prices; as long as inventories last, they prefer to wait and see the conflict’s development. Market-recognized profit margins are based on stable conflict resolution and lower commodity volatility, reflected in spot prices after stabilization. This explains divergence between stock and futures/spot trends. Before volatility drops, the market is driven by narratives and liquidity shocks, not frequent price signals or long-term expectations.

Market short-term adjustments amid uncertainty

Stocks that rose sharply earlier have recently fallen more

Since March, the structure of declines and relative institutional holdings do not match. The top four sectors held by institutions have fallen an average of 5.6% since March, with electric power and communications sectors posting positive returns, while the four sectors with the lowest institutional allocation have fallen an average of 8.9%. This suggests that the main driver of volatility is not institutional rebalancing but rather absolute return funds reducing positions. From a style perspective, low-valuation stocks are safer, while high-valuation stocks have fallen more; at the individual stock level, those with higher gains in the past two months have experienced larger declines—similar to the behavior of absolute return funds reducing risk. In a phase where valuation levels are high, profit margins are yet to be realized, and macro uncertainty increases, reducing positions is a rational move. At this stage, fundamentals give way to liquidity and narratives; stocks that surged on narratives in January-February are now correcting more sharply. This is normal, and there’s no need to overanalyze the price fluctuations.

Back to the starting line, decisions depend on April

1. Core issues regarding the Middle East conflict will gradually be answered after April. The key market questions will be clarified in April, but until then, the market remains in a narrative battle, reflecting liquidity withdrawal. US Treasury yields are rising rapidly—10-year yields jumped from 3.97% at the end of February to 4.39%, the highest since August last year. Globally, as risk sentiment recedes, countries are strengthening energy and resource security and accelerating electrification. China’s manufacturing competitiveness is just beginning to shift toward pricing power and profit margins. The market’s logic suggests that rising prices and PPI rebound are ongoing signals. The main concern now is whether upstream prices can transmit downstream—upstream sectors have started raising prices, but downstream remains cautious and inventory-digesting. Only over time, as commodity volatility decreases, will downstream procurement normalize, and whether industries can sustain price increases, expand profit margins, and convert share advantages into pricing power remains to be seen. Investors should remain patient and calm through price fluctuations. April and May are critical decision months. The first three months of the year were mainly driven by narrative-driven sector rotations; even if trading did not lock in gains, it’s not a big problem. Active equity funds’ median return for the year has already returned to 0.7%.

2. Firmly focus on rebalancing China’s manufacturing pricing power. The current core holdings should be sectors with China’s share advantage, high overseas re-shoring costs, and supply flexibility influenced by policies—namely, new energy, chemicals, electrical equipment, and non-ferrous metals. Recent liquidity shocks have brought valuations back to attractive levels, similar to the post-April 7, last year, with expectations of significant undervaluation and positive divergence. Based on this, continue increasing exposure to low-valuation factors, focusing on insurance, securities, and power. From a short-term cyclical perspective, price increases remain the “sharpest sword,” and PPI trading is increasingly likely to be the main theme for the year. Key opportunities include: 1) chemical products with alternative raw materials/process routes under oil price shocks (China’s “coal content” in these products is often higher than overseas competitors); 2) supply disruptions in regions with high capacity share, such as Middle East and Western Europe, could create supply-demand gaps and trigger price hikes; 3) demand-driven price increases in substitutes affected by costs; 4) products already in an upward price channel, with tight supply-demand balance and cost-driven price windows.

Risk factors

Intensified US-China technology, trade, and financial frictions; domestic policy strength, implementation, or economic recovery falling short; macro liquidity tightening beyond expectations; escalation of conflicts in Ukraine, Middle East, and other regions; China’s real estate inventory digestion falling short.