Is the chain reaction in the Middle East coming? Stagflation risks intensify

"Stagflation"

Goldman Sachs issued a very serious warning this morning: it said a global chemical crisis is breaking out, and the market severely underestimates its depth and breadth. The speed and magnitude of this shock is twice that of the European energy crisis in 2022.

Goldman Sachs states that the disruption in the Strait of Hormuz is triggering a global supply shock in chemicals, which is reshaping the supply chain at an unprecedented speed. Basic chemical product prices have soared more than 60% in recent weeks, the fastest rise ever recorded. Currently, about 20% of the world's chemical supply has already been interrupted.

Goldman Sachs believes that if the throughput of raw materials cannot be restored immediately, the previously low-probability tail risk scenario of supply chain interruption and sharp demand contraction will become the base case scenario.

Is it really that serious? Many investors instinctively feel this is just another round of energy crisis; the stock market already fell and is now recovering, right? But Goldman Sachs says this round of raw material shock is completely different from that of 2022.

2022 was a gradual shock, mainly affecting European natural gas. However, natural gas only accounts for about 10% to 15% of the production costs of chemical products.

This time, it's a leap in oil prices. Combined, oil and naphtha (an oil intermediate) account for nearly 70% of the cost of global petrochemical production, so the impact and its speed are not comparable to before.

Looking at the key points, the price surge and speed in chemical contracts this wave is twice that of the same period in 2022. And this shock is devastating for the Asia-Pacific region. Around 70% of Asia-Pacific's chemical feedstock is imported from the Middle East. Yet, Asia-Pacific contributes 65% of global chemical production and 51% of global manufacturing output.

Even more noteworthy is the shock transmission path. Initially affected were low value-added links such as textiles, packaging, and automotive parts, but now it's beginning to spread upward to high-value sectors. One sign is Korea’s semiconductor and memory chip production, where these factories are now facing the risk of shortages in critical chemical solvents.

Therefore, Goldman Sachs believes that once this supply cutoff chain spreads, there will be a tail risk for semiconductor supply that no one is pricing in.

Moreover, even if the Strait of Hormuz reopens immediately today, there will still be about a 140-day delay before feedstock is delivered to Asia or Europe. That means, in the most optimistic case, relief in physical feedstock will not come until mid-to-late September.

At the end of its report, Goldman Sachs warns that while market participants have noticed warning signals in the petrochemical industry, they have not fully appreciated their severity, largely because the shock isn’t being directly felt yet. Each day the Strait of Hormuz remains blocked pushes this left-tail risk scenario closer to becoming the base case.

Jason believes that if the peak in passing raw material costs to end-consumer prices happens in the second half of this year, it will coincide with the window when the market currently expects the Federal Reserve to cut rates. In other words, the market now expects inflation to keep falling, growth to slow moderately, and policy to have room to turn accommodative. But if costs in oil, naphtha, packaging materials, auto parts, apparel fibers, etc. start passing through to the end market, the Fed won’t be facing a clean disinflationary process; instead, there may be secondary inflation pressure due to supply shocks.

This is also a typical stagflation risk: on one hand, rising costs squeeze corporate profits and drag down real demand; on the other hand, price pressures re-emerge, limiting the central bank’s room to cut rates—this is the macro backdrop least favored by the market.

So the key question is: has the market already priced in this risk? Jason believes probably not yet.

One signal to watch is the VIX. On the surface, the VIX remains below 20, suggesting not much panic at the index level. But that doesn’t mean there’s no risk inside the market. Strictly speaking, the VIX reflects the 30-day implied volatility derived from S&P 500 option prices. Looking at the structure of index volatility, volatility of individual stocks and correlations between stocks also influence overall index volatility. So what about individual stock volatility and correlation now?

Currently, many individual stocks and industries are seeing considerable volatility, but the correlations between stocks are very low. AI is trading on its own growth story, banks are trading on rates and the credit cycle, consumer stocks are trading demand resilience, energy stocks are trading oil prices. The market appears to consist of many independent narratives. Because these sectors aren’t moving together, index-level volatility is suppressed.

But Jason believes this low correlation itself may be the risk. Because once chemical and energy costs begin to spread along the supply chain, many independent stories may eventually be pulled back to one macro backdrop. Furniture, clothing, autos, packaging, logistics, semiconductor manufacturing may appear to be in different industries, but they all face similar squeezes from feedstock, logistics, inventory, and margins. At that point, market correlations may quickly rise and the VIX may no longer remain this calm.

Of course, the market isn’t completely oblivious to supply chain risk, but may be underestimating the speed at which it moves from sector shocks to a macro-level shock. Once this risk spreads faster, the previous market preference for divergent narratives in different sectors will be weakened and the market may return to addressing the same issue.

So are there any assets that are relatively safer? In my view, it’s still AI and high-end tech stocks. The reason these companies have regained attention recently is partly because their core value comes from algorithms, data, computing power, and platform advantages, unlike traditional manufacturing which directly consumes large volumes of petrochemical feedstock per unit product. From this angle, tech assets do possess a certain degree of inflation resistance. Thus, at this moment, large tech companies closely linked to AI still offer relatively higher risk-reward.

But this inflation resistance shouldn’t be idolized. The AI industry still relies on chips, servers, data centers, electricity, cooling systems, special gases, and high-purity chemicals. If supply shocks further impact semiconductor manufacturing, the AI industry chain cannot remain completely untouched. More importantly, if inflation rebounds and pushes up interest rate expectations, growth stock valuations will also feel the pressure.

Therefore, Jason prefers to think of AI as a relatively inflation-resistant asset, not an inflation-immune one. In a rising stagflation risk environment, AI might be more resilient than traditional low-value-added manufacturing, but it cannot fully hedge against supply chain and interest rate shocks, or the systemic risks arising from an increase in market correlations.