Royal Bank of Canada(US:RY) Sou Hu Cai Jing·2025-06-17 03:21Core Viewpoint - The Canadian Royal Bank (RBC) warns that the ongoing geopolitical conflict between Israel and Iran poses three significant risks that could trigger a decline in the U.S. stock market, predicting a potential drop of up to 20% in the S&P 500 index, bringing it down to the range of 4800 to 5200 points [1] Valuation Perspective - RBC strategists note that during periods of heightened geopolitical uncertainty, the price-to-earnings (P/E) ratio of the S&P 500 typically contracts. Historical data shows that despite fluctuations, the U.S. stock market has not reached levels deemed "cheap" during the tariff crisis in April. Currently, the market is approaching historical highs, indicating vulnerability in valuations against adverse news, which could lead to significant stock price volatility if expectations for economic growth and corporate earnings change [3] Market Sentiment - Changes in market sentiment are crucial for U.S. stock performance. Recent stock market gains have largely been driven by improved investor sentiment. However, the escalation of the Israel-Iran conflict could disrupt this optimism. Evidence of caution is already present among businesses and consumers, with CEO confidence dropping to a three-year low according to the Conference Board's latest survey. Although consumer confidence saw a slight rebound in May, concerns over tariffs and extreme weather events persist. Increased mentions of geopolitical risks in corporate earnings calls indicate that business leaders are factoring these risks into their considerations, which could weaken market buying power and trigger stock price corrections if investor sentiment shifts [4] Impact on Inflation and Monetary Policy - The conflict's impact extends to inflation and monetary policy. RBC's commodity strategists warn that if the conflict disrupts oil supply in the Middle East, oil prices could rise further. This increase would elevate production costs for businesses, potentially leading to inflation. RBC estimates that the conflict could push the preferred inflation measure of the Federal Reserve, the Personal Consumption Expenditures (PCE) index, up by as much as 4%. Heightened inflation would limit the Federal Reserve's monetary policy options, which are crucial for sustaining the anticipated bull market in 2025. The ability to lower interest rates is essential for reducing corporate financing costs and stimulating economic growth. However, if inflation remains high, the Fed may have to reduce the frequency of rate cuts, which would exert pressure on stock valuations and decrease the attractiveness of U.S. equities, leading to capital outflows [5]