Markets staged a sharp recovery in April, returning to all-time highs despite a geopolitical backdrop that would normally be expected to weigh more heavily on investor sentiment. Resilient corporate earnings growth and continued AI related investment helped investors look through the disruption in oil markets, highlighting the importance of staying focused on the underlying economic and earnings backdrop rather than reacting to short-term headlines.
Markets rebound as earnings take over the narrative
At one point, around four weeks into the US-Iran conflict, the S&P 500 was down around 9% from its highs. Since then, markets have recovered those losses and moved meaningfully higher. The S&P 500 rose around 10% in April, its strongest month since late 2020, and is now more than 5% above where it started the year.
For some, this will be a surprising outcome given the disruption to global oil flows. Almost no oil has moved through the Strait of Hormuz over the past two months, particularly since the US counter-blockade was put in place. Yet despite the scale of the disruption, equity markets have behaved as though the shock will prove temporary.
Part of that reflects hopes of de-escalation and the possibility that the Strait could reopen soon. However, the bigger driver has been the resilience of the US economy and the strength of corporate earnings.
The consumer impact is still manageable
Higher oil prices are clearly unhelpful, but the direct impact on consumers needs to be kept in perspective. Even after the recent rise in petrol prices, gasoline and other fuels account for only around 3.5% of US consumer spending. That is not insignificant, but it is also not enough on its own to derail the consumer, particularly while employment remains strong.
The bigger risk is the second-round impact. Energy is an input into almost everything, from transport and production costs to airline costs and food distribution. The direct hit to household budgets may be manageable, but the broader inflationary impact could become more problematic if higher energy prices persist. Markets can usually handle a short-term oil spike. What they struggle with is a sustained inflation shock that forces central banks to stay tighter for longer, while also weighing on real incomes and corporate margins.
Companies are not yet seeing a major slowdown
One useful way to cut through the noise is to listen to what companies are saying. Across company calls and management updates, the message has been relatively consistent - uncertainty has risen, particularly around energy prices and inflation, but there is little evidence of a broad-based slowdown.
Consumer confidence has softened, but this has not yet flowed clearly into spending behaviour. Banks are still seeing consumer spending growth, payment trends remain healthy, and delinquencies are controlled. Payroll software providers are not seeing a meaningful change in employment levels, while industrial demand and business-to-business activity also appear to be holding up.
Earnings and AI remain the market’s anchor
Over the long term, share markets are ultimately driven by company profits. On that front, the picture remains strong. Expectations for US corporate profits have risen materially over the past three months, despite the conflict, with the largest 500 companies in the US expected to grow earnings at close to a 20% rate over the next three quarters.
US corporate earnings growth accelerating
The latest earnings season has also been better than feared. With more than two thirds of the S&P 500 having reported their financial results, around 81% of companies have beaten first quarter earnings estimates. That has provided a powerful offset to the geopolitical uncertainty.
The AI investment cycle remains one of the clearest supports for the economy and markets. Large technology companies continue to spend heavily on data centres, cloud infrastructure and computing capacity, and recent results reinforced the view that AI-related investment remains a major driver of growth.
Solid fundamentals, but still a range of outcomes
In a sense, the geopolitical backdrop is masking what are otherwise solid fundamentals. Without the oil disruption, markets would likely be higher than they are today.
The risk is that the Iran conflict lasts long enough to create a more serious inflation and growth problem. There have been signs of progress, with reports that Iran has put forth a new proposal and is prepared to re-engage diplomatically. That has helped oil prices ease and supported markets, but the situation remains fragile. If the conflict drags on, oil prices could move materially higher, reigniting inflation and weighing on growth.
That is not our base case, but it is a risk markets need to respect. A sustained inflation shock would pressure valuation multiples and could create an environment more like 2022, when both equities and bonds struggled. In the more likely scenario, the conflict eases, oil prices fall, and markets refocus on the stronger underlying backdrop.
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