Shortages Drive Capital Flows; Watch for Middle East Risks and AI Valuation Bubble

Overview

This report analyzes the core drivers of global markets in May 2026, noting that although Iran’s ceasefire has alleviated extreme tail risks, the 'shortage' narrative—centered on energy and AI supply chains—continues to dominate capital flows. Following a rapid rebound, risk distribution across markets has become more balanced, yet geopolitical escalation and elevated AI valuations remain key vulnerabilities. The report contends that, while awaiting greater clarity on the geopolitical situation, investors should focus on assets benefiting from shortages while deploying volatility and options strategies to hedge downside risk.

Core views

Risk mitigation and shortage-driven dynamics. Iran’s ceasefire has enabled markets to look ahead, compressing risk premiums across asset classes. Despite elevated oil prices and yields, U.S. equities, high-carry/commodity-linked currencies, and emerging-market assets have all staged robust recoveries. This rebound is underpinned by physical shortages—whether in commodities or AI supply chains, particularly memory chips. Shortages compel higher prices to signal and attract necessary capital inflows, thereby supporting related asset prices in the near term. Geopolitics remains the largest tail risk. Although markets have priced in much of the relief, renewed hostilities in the Middle East or a prolonged closure of the Strait of Hormuz would trigger further oil price spikes, higher interest rates, and economic recession. The report argues that more severe negative tail risks are currently underpriced, recommending maintaining hedges such as out-of-the-money put options on European equities, credit, and FX, alongside long positions in crude oil. AI boom and surging capital expenditures. The AI theme has reemerged as a market focal point, with AI-heavy indices—including those of South Korea, Taiwan, and the Nasdaq—surpassing pre-war highs. Tech investment as a share of GDP has now exceeded its late-1990s peak, and capex forecasts for hyperscale data centers have been sharply revised upward. Yet, unlike the late 1990s, corporate earnings as a share of GDP have reached record highs, suggesting no macro imbalance of the classic kind. Value creation remains highly concentrated in semiconductors and memory. Macro optimism is already fully priced. Market-implied U.S. growth expectations stand at 2.5%, likely overestimating genuine cyclical optimism. With inflation poised to recede over the coming months as energy prices peak, policy easing space is constrained unless energy supply clearly normalizes. Upside pressure on bond yields may persist but is expected to eventually be capped. While the U.S. dollar appears stable on the surface, this masks intense internal divergence; the RMB possesses a structural basis for long-term appreciation, given China’s external surplus approaching historic highs. Opportunities in emerging-market carry trades. During the current stalemate—where there is no formal agreement to reopen the Strait of Hormuz but also no full-scale military conflict—emerging-market carry trades have performed exceptionally well. With central banks adopting a 'wait-and-see' stance, the bar for rate cuts has risen, causing real rates and carry levels to decline more slowly than expected at the start of the year. The report favors the Brazilian real, Hungarian forint, Mexican peso, and South African rand as long positions within an emerging-market carry basket.

Analysis framework

The report employs a 'shortage–price–capital flow' analytical framework, integrating geopolitical shocks (the Iran war) with technological industry cycles (AI investment) to assess their impact on broad asset classes. First, it evaluates shifts in the probability of tail risks (e.g., Strait of Hormuz closure) to gauge compression potential in risk premiums. Second, using volume-price decomposition and supply-demand frameworks, it identifies physical shortages—in energy and chips—as the core force driving price increases and capital reallocation. Third, it compares current tech investment as a share of GDP with historical peaks in the late 1990s, incorporating enterprise profitability metrics to assess the degree and sustainability of AI-related valuation excesses. Additionally, the report applies purchasing-power-parity and terms-of-trade analysis to explain the structural divergences underlying apparent U.S. dollar stability.

Methodology notes

• Industry/Sector Analysis FrameworkSupply-demand framework

  Physical shortage drives prices and capital flows

  The report states that when physical shortages exist (e.g., in energy or chips), prices must rise significantly to signal and attract the necessary capital inflows to expand supply. This logic is central to understanding current sharp asset price volatility.

• Event-Based Game Theory & Behavioral FinanceExpectation Gap / Expectation Management

  Pricing of tail risks and market tolerance

  After avoiding worst-case outcomes (e.g., full-scale war), markets rapidly compress risk premiums. However, this optimistic assumption renders markets more sensitive to new negative shocks; if expectations are disappointed, repricing can be disproportionately large.

• Corporate Fundamentals & Financial FrameworkOperating/Financial Leverage Analysis

  Tech investment as a share of GDP versus macro imbalance

  By comparing current tech capex as a share of GDP with the late-1990s internet bubble—and overlaying corporate profit shares of GDP—the report assesses whether today’s AI boom carries typical macro imbalance risks.

• Macroeconomic frameworkPurchasing power parity

  Trade surplus and exchange-rate equilibrium

  The report argues RMB appreciation reflects fundamentals—not just policy—given China’s external surplus as a share of global GDP nearing unprecedented levels, indicating strong export competitiveness and currency undervaluation; appreciation represents a return to equilibrium.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• South Korean, Taiwanese, and Nasdaq equity markets

  Beneficiary: Surging AI capex and memory chip shortages

  Strengths

  Directly benefits from AI investment boom; positive earnings revisions

  Weaknesses

  Valuations at cyclical highs; sensitive to macro shocks

  Comparison

  Higher AI exposure relative to other regions

  Risks

  AI investment returns fall short of expectations; valuation correction

• Energy producers (EM currency issuers with high carry, e.g., Latin America)

  Beneficiary: Elevated energy prices and carry-trade advantages

  Strengths

  High carry levels; benefit from improved terms of trade

  Weaknesses

  Vulnerable to global growth slowdown

  Comparison

  Outperforms energy-importing emerging markets

  Risks

  Sudden de-escalation in the Middle East triggers oil price collapse

• European equities, credit, and FX

  Hedge instrument: To hedge tail risk from Middle East escalation

  Strengths

  Offers best value among cross-asset instruments for out-of-the-money downside protection

  Weaknesses

  Hedge cost may be lost if risks ease

  Comparison

  More effective hedge than simply shorting U.S. equities

  Risks

  Geopolitical tail risk fails to materialize

Key data

• Market-implied U.S. Growth Expectation2.5%Estimated implied U.S. growth expectation derived jointly from equity and bond market movements
• Tech Investment as Share of GDPExceeds late-1990s peakCurrent tech capex as a share of GDP has surpassed the high point of the internet bubble era
• Consensus Forecast for 2026 U.S. Hyperscale Data Center Capex$75.5 billionSharply revised up from $67.3 billion at the start of Q1 earnings season
• Consensus Forecast for 2027 U.S. Hyperscale Data Center Capex$89 billionSharply revised up from $79 billion at the start of Q1 earnings season
• S&P 500 Implied Volatility TrendStructurally risingLong-dated implied volatility has shown a clear upward trend since last September—even amid strong equity gains

Impact & implications

The report concludes that, so long as shortages remain unresolved, price strength in energy- and AI-related assets may persist. For bond markets, AI infrastructure build-out and defense-related fiscal spending will constrain yield downside. In FX markets, the U.S. dollar’s broad stability masks divergences among commodity-linked and high-carry currencies; investors should distinguish between energy exporters and importers. A broader resolution of the Iran conflict would cushion risk-asset trajectories via easing interest-rate pressure and eliminating growth tail risks—but given current optimistic growth pricing and concentrated positioning, volatility remains likely.

Risks

• Renewed hostilities in the Middle East or prolonged closure of the Strait of Hormuz, triggering oil price spikes, higher interest rates, and recession.
• AI-related investments delivering subpar returns, leading to valuation corrections and aggregation/extrapolation fallacies.
• Sticky inflation exceeding expectations, preventing central banks from cutting rates as anticipated—or even prompting renewed hikes.
• Private credit issues generating systemic consequences (though the report judges this likelihood low).

What to watch

• Progress on an Iran peace agreement and reopening of the Strait of Hormuz.
• Duration of energy commodity shortages and emergence of new supply sources.
• Sustainability of AI capex and realization of corporate earnings.
• Evolution of core inflation data—particularly transmission effects following the peak in energy prices.
• Changes in China’s external surplus and RMB exchange rate trajectory.