Three things move markets: inflation, which acts as a tax on returns, the consensus of the buyers and sellers (collectively known as “the crowd”) represented by the flow of funds into or out of a market, and interest rates, which can legitimize or refute current market levels by what they offer in terms of return with less risk in higher yield investing.
Based on these three items, along with several quantitative attributes, in our view, this is a very overvalued market in the aggregate. Domestic inflation is rising rapidly as the effects of higher oil prices and its proxies permeate the economy. Estimates suggest that food, transportation, fertilizer prices, and plastic inputs are all heading to double year-over-year if not already. The current market P/E ratio of 20.9 is at a high, and above the past decade’s average of 18.9. The government inflation data, which may reflect lagged effects of price changes, is going up for at least the next six months assuming current conditions persist. The current price refineries pay is approximately $130/barrel.
It is possibly an even worse situation outside the US, as countries in Europe, Asia, and Africa deal with price surges that were not even being discussed two months ago. As many of these smaller countries spent the past year grappling with the sudden tariffs imposed last April, their reserves of foreign currency to meet the current emergency is minimal to non-existent.
This is in some ways the mirror image of what occurred in the early 1970s, when the US produced about 30 percent of its oil and imported the rest. Days of long gas lines were common. There was in several states a system of even/odd gas station admission (based on the last digit on your license plate). The then newly formed oil cartel of OPEC was more generous with its supplies to countries it did not consider supporters of the Shah of Iran. Today, the US is almost self-sufficient in energy. The rest of the world outside the Middle East is not.
There is a divorce between the current experiences of Wall Street and Main Street. Wall Street is hitting new highs while Main Street deals with a population that is increasingly challenged in its efforts to stay solvent. While taxes are lower for many, higher health care, food and energy cost makes the reduction in government taxes something of a shell game. Wall Street keeps pushing up the values of technology stocks, especially semiconductors. For various reasons the investor class is doing well, the non-investor class less so.
What history teaches us is that this discrepancy in terms of abundance between Wall Street and Main Street eventually closes. Often it does so when Wall Street runs out of buyers for their ever higher priced subsets of securities that are generating the bulk of returns. For most, this will only be obvious in retrospect.
Interest rates are currently something of an enigma. Major disruptions such as ongoing geopolitical tensions involving Iran would normally see a flight to safety as the US dollar has been the world’s reserve currency since the end of the Second World War. Thus, it would be expected that interest rates would go down as foreign investors seek the sanctuary of US government investments. This time interest rates have been stable, and it was the value of the dollar that has declined.
A declining dollar is not attractive as an investment to a foreign person or entity. Whatever is earned in interest on treasury securities can be wiped out by the dollar’s decline. Up until the issuance of tariffs on a global scale, the dollar was appreciating against other currencies. With the direction now reversed, the only way to entice foreign investors back is to have higher interest rates. For this and the fact that the US is generating $1.5-2 trillion a year in deficits to be financed, to say nothing of the cost of the geopolitical tensions (which will be in the billions), the path to higher interest rates appears likely based on current conditions. These two factors, higher interest rates and currency depreciation, are likely to contribute to inflationary pressures going forward.
Wall Street has little regard for these arguments. The opinion seems to be that the facts speak for themselves. Higher prices are higher prices, regardless of how they come about. Markets continue to move higher despite these concerns.
While the argument seems impressive on its face, it is important to remember that it is what you keep and not what you make that matters. Even long-term capital gains taxes are a small price to pay for realizing the return on an investment. Unrealized gains are just that. Only realized gains matter in the end. There is an old Wall Street maxim: Bulls make money. Bears make money. Pigs get slaughtered.
The Economy
The US economy continues to impress. This is in large part due to the deficit government spending coupled with the government expenditures. Finally, there is the capital spent on Artificial Intelligence (AI), which is projected to be 2.2 percent of total GDP for the year, based on available data. Five years ago, tech capital spending was less than a tenth of this size.
Looking ahead, there is a risk that higher interest rates, higher prices, and the layoffs resulting from AI’s implementation may start to erode the economy’s gains. The US economy is still expected at this point to generate positive returns for the year, but it may not be as strong as predicted when the year began.
Interest Rates
Interest rates are likely to have an upward bias for the next 12-18 months. This was not the scenario wanted by the administration, who tried (to no avail) to pressure the Federal Reserve Chairman to leave so that someone who would entertain lower rates could be selected.
An interest rate higher than the inflation rate makes the cost of borrowing “real” in the sense that there is an after-inflation cost of money. The president wanted a lower rate that would encourage speculation and otherwise run the economy “hot” during the elections.
The new Fed Chairman Kevin Warsh is of the opinion that it is not the Fed’s role to support the stock market. This would represent the first change in this policy since at least Alan Greenspan. As the President often validates his actions by the level of the stock market, this may make for some clashes.
Inflation
Those who think we have already seen the worst of inflation from the geopolitical tensions may be disappointed. The price of oil alone could rise further under current conditions.
This is because of the difference between the futures and cash oil markets. The futures markets are for settlement at some time in the future; traders in futures contracts seldom take delivery of the oil they are trading. The cash market is what refineries will pay upon delivery. Given the supply disruptions, various reports indicate that the cash market is higher than the futures market by $30-35/bbl. Cash prices dictate the price of gasoline and refined products, not the futures market.
The Stock Market
The market is evolving to one that is less represented by ETFs and indexes, and more the providence of those who can choose the superior investment as opposed to the superior market or sector.
This is also a market that, depending on your view of interest rates and inflation, can offer high cash flow returns for investments that have solid earnings and balance sheets. Significantly, many ETFs do not distinguish between those investments that are solid and those that are not. If you buy a sector or index, you can get all kinds.
Warren M. Barnett, CFA
April 28, 2026
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