Recent sharp fluctuations in global stock and commodity markets have been primarily driven by escalating tensions in the Middle East. From a purely investment perspective, geopolitical conflicts themselves are often not as alarming as they seem. A brief review of history shows that most conflicts do not fundamentally alter the market's underlying trend. For instance, the ongoing Russia-Ukraine war, which is far larger in scale than the current US-Iran conflict, has not prevented global economic and market prosperity in recent years.

However, the current conflict differs because it targets a critical component of the global economy: oil prices. Although Iran's oil production is less than half of Russia's and its reserves are far smaller than Venezuela's, its impact on oil prices is more significant. This is primarily because Iran controls the Strait of Hormuz, a vital chokepoint for global oil transportation.

The Strait of Hormuz handles 14 to 15 million barrels of crude oil per day, accounting for 31% of global seaborne oil shipments. Over 90% of crude exports from the Persian Gulf region pass through this strait. In early March, Iran announced a "selective blockade" of the strait, causing transport volumes to plummet by 90% and at times halting traffic entirely. The disruption in Middle Eastern oil exports has directly fueled a surge in oil prices, which rose from around $70 to over $100 in just over half a month, even approaching $120 at its peak.

As the lifeblood of economic development, oil is not an isolated commodity but a macroeconomic variable with broad implications. The most direct impact is a sudden rise in global inflation risks, which triggers a chain of negative reactions—most notably, delaying the Federal Reserve's interest rate cuts. In its latest policy meeting, the Fed adopted a more hawkish stance, refraining from rate cuts while significantly scaling back expectations for reductions within the year. For the first time, it even publicly discussed the possibility of rate hikes, sparking a global market selloff, with Chinese stocks also affected.

At this point, some may ask: Shouldn’t rising inflation be a positive development? According to macroeconomic cycle theory, inflation is the most critical variable affecting stock market fundamentals because it reflects the supply-demand balance in the real economy, directly determining corporate profits. Generally, rising inflation indicates an overheating economy where demand outstrips supply, leading to improved corporate earnings—a clear positive for equities. Thus, it has been argued that only when inflation reverses and rises will Chinese stocks transition from a valuation-driven "water bull market" to a profit-driven "real bull market."

So why has the recent uptick in inflation been perceived as negative? The answer lies in the underlying mechanisms of inflation.

Inflation is fundamentally determined by supply and demand in the real economy. Deflation signifies oversupply and excess capacity, while rising inflation indicates insufficient supply relative to demand. Specifically, depending on the cause of the output gap, inflation can be driven by two scenarios: demand-pull inflation, where supply remains stable while demand expands significantly, or cost-push inflation, where demand remains unchanged but supply contracts sharply or production costs rise, forcing prices upward. The latter often stems from shortages in key production factors, such as the recent oil supply crisis or labor and material shortages during the pandemic.

While both types of inflation create an output gap where demand exceeds supply, their implications for the economy and markets differ drastically.

Demand-pull inflation is healthy and beneficial for the economy and markets. It signals robust economic recovery, with industries struggling to meet rising demand. Producers raise prices voluntarily, while consumers, with higher incomes, are willing to pay more. Companies experience both volume and price growth, leading to improved profits. Moreover, increased wealth and risk appetite among investors boost potential capital inflows into stocks, elevating market valuations.

A prime example is the U.S. post-pandemic inflation. Aggressive monetary easing and fiscal stimulus fueled a surge in inflation to multi-decade highs, driven by strong economic recovery, rising per capita incomes, and robust consumer demand. During this period, corporate profits improved markedly, and investors, flush with cash and higher risk tolerance, drove U.S. stocks into a bull market fueled by both earnings and valuation expansion.

Similarly, China experienced an inflation upturn from late 2020 to 2021. Supported by policy stimulus and a final surge in real estate activity, economic demand strengthened significantly, pushing inflation higher. Corporate profits improved, investor enthusiasm soared, and Chinese stocks enjoyed their strongest bull market in nearly a decade.

In contrast, cost-push inflation is unhealthy and detrimental to the economy and markets. It indicates a severe supply-side shock, where supply contracts passively and rising costs drive inflation, pushing the economy into an inflationary state without corresponding demand improvement. This erodes corporate profits by raising production costs while increasing living expenses for consumers, reducing real incomes.

If economic demand is strong, these issues are manageable. Companies can pass higher costs to consumers, who, with rising incomes, can absorb the price increases—as seen in the U.S. in recent years, where soaring prices were offset by rapid income growth.

However, if demand is weak or stagnant, persistently high prices and declining real incomes can drag the economy into stagflation—a scenario of weak growth coupled with inflation. This severely harms corporate profits: rising production costs force companies to raise prices or even halt operations if costs become unsustainable. Meanwhile, weakened consumer purchasing power makes products harder to sell, further eroding profits and demand, creating a vicious cycle.

Compounding the problem, high inflation limits policymakers' ability to stabilize the economy through monetary or fiscal stimulus. Instead, they may be forced to tighten policy, further dampening demand and exacerbating the downward spiral, potentially leading to recession. The Great Stagflation of the 1970s serves as a stark example…