Unsurprisingly, events in the Middle East continue to dominate the headlines. Back in the days when I more often picked up a physical newspaper, I’d start at the back with the sport and reverse my way through the content via the financial section to the ‘news’. It wasn’t always less stressful, though! 

The back pages on Monday would have focused on Northern Irish golfer Rory McIlroy’s addition of a second Masters’ Green Jacket to his wardrobe. A chart of his first three-and-a-half days’ performance at the event reflects this year’s stock market moves: a very strong start, despite having to extricate himself from a few sticky situations, followed by a nasty wobble born of poor decision-making and bad execution. All exacerbated by spirited counterattacks from his rivals. 

But that’s where the analogy ends for now. There’s no march to victory in the air just yet. With US President Donald Trump imposing a blockade on all traffic traversing the Strait of Hormuz, the trickle of oil that had started to pass through is once again reduced to nothing. This is high-stakes poker. The plan seems to be to reduce Iran’s revenue to the extent that it has no option but to capitulate. However, we’ve already seen that the country is willing to tolerate a lot of pain. The longer cargoes remain trapped in the Gulf, the greater the probability of not only higher global inflation but also much weaker growth as various commodities beyond oil itself become not just expensive but impossible to obtain. 

We (and the majority of investors) continue to judge this escalation as an integral part of the negotiating process, however dangerous it appears to be. Thus, we continue to see relatively muted market reaction to the latest developments. 

Last week we saw another example of how markets react when the news turns for the better. The announcement of a two-week ceasefire and talks between the US and Iran in Islamabad – another example of ‘Trump always chickens out’ (taco), his tendency to pull back from the brink – were greeted with an instant mark-up of most financial assets. The rally wasn’t as pronounced as on 23 March, when President Trump first announced the beginning of the end of the war, but there is a visible gap higher on the charts. Once again we’re reminded that waiting for the good news to break before committing to the markets means leaving returns on the table. As long as we believe that all logic leads to an agreement in the not-too-distant future, we’re staying fully invested but always cognizant that there’s no guaranteed outcome. And there are at least two parties (the US and Iran) that have to agree to terms. If Israel also agrees, the path to peace would be smoother.

Clues in the bounce

A few things have been revealed by the nature of the market bounce since the beginning of the month. There seems to have been a bit more support for large- cap technology companies in the US than before the war started. We’ve detected some improvement in sentiment regarding the adoption of AI tools as the tools themselves appear to have become more effective. Even bigger rallies were seen in memory chip stocks (Samsung, SK Hynix) in South Korea, which had suffered a big shakeout from speculative peaks made in February. Even so, the performance gap between IT hardware and software & services companies opened up again, with the former outperforming the latter by close to 10% in April so far. Investors are still struggling to sort out software winners and losers. 

Europe's energy vulnerability

We also note that, having fallen by more than global aggregate indices in March, European equities have failed to recapture the ground they lost, relative to global indices. Two factors are at work here. First, Europe is vulnerable to energy price increases and/or product shortages owing to its lack of domestic supplies. Second, if improving sentiment towards AI ‘spenders’ is justified, then European indices have limited exposure to the theme. In recognition of these handicaps, we became more cautious about European equities in March. 

It’s not all bad news, though. The defeat suffered by Prime Minister Viktor Orbán in Hungary’s parliamentary elections on Sunday removes a blockage to some of the EU’s policy ambitions. Crucially, it potentially permits a €90bn loan by EU member states to Ukraine  , which will keep it funded through 2027. That might reduce the threat of further damaging escalation from Russia. 

The final observation is that sovereign bonds failed to recover much lost ground either. Having sold off alongside equities in March owing to concerns about higher inflation and fiscal deficits, the threat of structurally higher and more volatile inflation continues to hang over them. Investors are demanding higher yields as compensation.

The acid test for equities

There are really only two things that define equity returns: how much they earn and what investors are willing to pay for those earnings. The latter is all over the place at the moment as the risk-free rate – the rate of return on an investment with no risk of loss – moves around rapidly and the tolerance for risk falls and rises with the latest news from the Middle East. But, as we head into the first quarter earnings season, we should get a fair view of corporate earnings power – even if what comes next is less certain. 

Expectations going into the season are good, especially in the US. Investment strategists, on average, are looking for earnings to have grown 12% since last year, and for the same pace for the whole of this year relative to 2025. Aggregated forecasts from individual stock analysts are looking for an even punchier 17% annual growth rate… And then the same again in 2027! 

US tech tailwind

The US benefits from strong growth from the technology sector, a tailwind unavailable to most other markets. Indeed, Goldman Sachs calculates that no less than 87% of the first quarter’s earnings growth will have been generated by the technology sector, with almost two-thirds of the total coming from just seven AI-related stocks (with chipmaker Nvidia alone accounting for 35%). There have been signs that earnings participation is broadening out, but it’s still top heavy. 

Goldman has provided a range of earnings forecasts for the S&P 500 in 2026 under different scenarios for the situation in the Middle East. The base case is for $312 of earnings (+12%). A mild oil shock reduces growth close to zero ($278). An oil shock-driven recession would cut earnings to $239 (-13%) in their opinion. These look like reasonable estimates.

The biggest variable factors are the  duration of the closure of the Strait of Hormuz and the consequent influence on commodity supplies. When they really get short, then economic problems will not be primarily because of high prices and spending displacement, but more about certain activities simply grinding to a halt. 

The risks of more negative outcomes, which remain far from negligible, restrain us from increasing equity weightings in portfolios. But the sort of upside squeezes that we have already experienced illustrate the potential problem with reducing exposure. While we wait to see whether President Trump’s high-risk strategy results in an eagle or a lost ball, we’re maintaining a prudent balance between potential risks and rewards in light of the uncertainty.
 

Signs of peace in the Iran conflict have supported stock markets, at least for a while