If you went on vacation in February and came back today to review your portfolio, you would be forgiven for not realizing that we’ve witnessed another war and the largest energy supply chain stress in decades. On top of that, we have large fiscal deficits, questions about Fed independence, shrinking demographics, U.S.-China tensions, cybersecurity risks, and elevated valuations, among other risks on the horizon. Yet global equities are up 10% year-to-date, led by emerging markets at 20%, followed by U.S. equities at 9% and the rest of world developed markets at 7%. What do markets know that most of us don’t see in today’s media headlines?
There are several reasons driving the market’s optimism today:
First, oil prices have not risen as much as expected, partly due to unusually high pre-war inventories, strategic reserve releases, a shift to renewables in China, and reduced demand from rationing in Asia and the cancellation of less-profitable flight routes globally. Further, oil at 100 is not unprecedented; oil intensity is much lower than it was 50 years ago, and the market continues to believe the shock is temporary, allowing it to look past the current pain for now.
Second, U.S. data remains strong. Manufacturing data and capital goods orders have remained solid while consumer spending is holding up, with core retail sales increasing 0.7% in March. Employment data came in strong for April, and high-frequency labor market indicators point to continued labor market stability.
Third, AI continues to be a dominant force, benefiting both U.S. and non-U.S. earnings. U.S. earnings grew 23% year-over-year in Q1 on the back of AI-related sector growth, but many key hardware components are produced abroad, resulting in a strong quarter for equity earnings elsewhere, too. With revenue growth up and margins increasing, there is no reason for companies to cut back today.
Lastly, fiscal support should not be discounted for the relief it brings. Governments globally have decreased energy taxes. Europe is investing in national security and infrastructure projects, while the U.S. is providing tax refunds to tip earners, overtime workers, and large R&D spenders through the OBBBA passed last year. Not to mention opportunistic tariff and sanction relief that has largely gone unnoticed by the media.
In short, there are many positives outweighing the short-term oil shock. Will this continue? Historically, oil shock damage tends to accumulate rather than impact markets right away, typically with a 12-18 month lag. A recession in the next 1-2 quarters is therefore unlikely. Continued AI capex and earnings strength will likely provide cover for markets to make further progress in the near-term. From an investor’s point of view, remaining invested in the short term is the right course of action. We continue to recommend global portfolios, including emerging markets, to mitigate concentration risk and participate in global market upside should the risk of an Iran War subside.
Market Expectations Still Skewed to the Upside
The Global Economy Uses Much Less Oil Per Unit of GDP Than Before
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